Under California Labor Code 351every gratuity is hereby declared to be the sole property of the employee or employees to whom it was paid, given, or left for.  The Labor Code also prevents employers from deducting credit card fees from the tips. The state’s Division of Labor Standards Enforcement (DLSE) has made further clarifications related to whom tips can be distributed to among staff.  The guidelines say that employees whom provide “direct table service” or are in the “chain of table service,” provided that the employee in the chain of service bears a relationship to the customers’ overall experience, can share in tips.  DLSE has determined that an involuntary tip pooling policy is acceptable as long is it is not used to compensate the owner(s), manager(s), or supervisor(s) of the business, even if these individuals should provide direct table service to a patron or are in the chain of service to a patron.

Automatic Gratuity

Automatic gratuity is considered taxable by the California Board of Equalization.  Their guidance can be found here.  While optional gratuity is not taxable, mandatory gratuity and service charges related to meals are taxable.  Please see the State’s guidance on this and those service charges that are not taxable here.   Additionally, in 2014, new IRS rules went into effect regarding automatic gratuity or service charges, which has determined that these constitute non-tip wages. These non-tip wages are subject to social security tax, Medicare tax, and federal income tax withholding. In addition, the employer cannot use these non-tip wages when computing the credit available to employers under section 45B of the Internal Revenue Code, because these amounts are not “tips.”