Service Charges vs. Automatic Gratuity in the Hospitality Industry

In recent years, hospitality operators have been revisiting how they handle added fees on guest checks. Changing labor laws, shifting guest expectations, and updates related to tip taxation have prompted businesses to rethink their long-standing policies.

This Q&A will help you understand the difference between service charges and automatic gratuities so you can choose an approach that fits your team and business model best.

What’s the Difference Between a Service Charge and an Automatic Gratuity?

A service charge is a mandatory fee that a business adds to the bill. The company collects the fee and decides how it is used or distributed.

Automatic gratuity is also a preset amount that is commonly applied to large parties. However, it originated as a way to support servers managing big tables that require extra time and attention. Guests may still add an additional tip on top of it.

How Do These Fees Relate to Traditional Tipping?

Traditional tips are voluntary amounts added by guests based on their personal experience. Under OBBBA, up to $25,000 of voluntary tips aren’t taxed for the individual. This has renewed interest among operators in reviewing their policies and considering how best to support their teams.

RELATED CONTENT: BIZ TIP

7 WAYS OBBBA IMPACTS THE HOSPITALITY INDUSTRY

OPEN IN NEW WINDOW

How Does the IRS Treat Service Charges and Automatic Gratuity Compared to Tips?

Service charges and automatic gratuity are considered wages. They run through payroll, appear on a W-2, and are subject to standard tax withholdings. Service charges and automatic gratuity are not considered tips and are not eligible for the OBBBA individual tax breaks. They also are not eligible for the employer tip credit.

Why Did Automatic Gratuity Become Common in Restaurants?

It began as a practical way to protect servers from receiving very low tips on large, time-intensive tables. Big groups often require additional coordination, pacing, and attention. Automatic gratuity gave operators a way to support staff who took on those demanding sections.

Are Businesses Still Using Automatic Gratuities the Same Way Today?

Many still do, but preferences among employees have shifted. Some staff members prefer tip income instead of wages because the tax treatment is different. As a result, some businesses are experimenting with giving servers the discretion to use automatic gratuity on groups when they feel it’s appropriate verses mandates. This approach can motivate strong performance while still providing a safety net for unusually demanding parties.

RELATED CONTENT: BIZ TIP

NAVIGATING TAX STRATEGIES IN THE HOSPITALITY INDUSTRY

OPEN IN NEW WINDOW

What are Some Pros and Cons of Using Service Charges?

What About the Pros and Cons of Automatic Gratuity?

How Do These Policies Affect Banquet or Event Environments?

Banquet operations often function differently. An automatic gratuity may be part of the contract, but it isn’t always paid directly to staff. Sometimes employers raise base wages instead and do not pass automatic gratuities through. Employees typically know their compensation structure before accepting the event shift.

Is There a Single Best Policy for All Hospitality Businesses?

No; each business must look at its own staffing model, financial structure, and competitive landscape. Operators also need to think about how their policies affect hiring: employees will compare opportunities, including how much income is taxed and how predictable pay feels.

If a Business Wants to Revisit Its Policy, What Steps Should It Consider?

• Review how current fees are described on menus and receipts
• Evaluate whether the policy aligns with employee preferences and guest expectations
• Consider giving servers some discretion in applying automatic gratuity
• Analyze how changes will affect payroll, benefits, and take-home pay
• Collect feedback from staff and guests regularly

Transparency goes a long way toward building trust on both sides.

Can a Guest Still Add a Tip If Automatic Gratuity is Used?

Yes. Guests can always write in an additional amount. That added amount is treated as a traditional tip rather than wage income.

RELATED CONTENT: BIZ TIP

QUESTIONS ABOUT TAXES AND TIPS? HERE ARE SOME ANSWERS FOR EMPLOYERS

OPEN IN NEW WINDOW

Which is Best for Your Company?

Choosing between service charges, automatic gratuity, or a hybrid model requires thoughtful evaluation. Each approach influences staff income, tax treatment, guest perception, employer tip credit and operational planning.

The best path depends on your business model, your team, and the expectations of your guests. Regularly reviewing your policy helps you stay competitive and aligned with both legal requirements and staff needs.