Difference Between Service Charges and Tips

Last updated: Feb 24, 2026, 9:57 AM

Learn the difference the IRS designates between service charges and tips and then see some Toast Payroll specific reports that can help you review this information.

Tips and Service Charges are common ways to pay restaurant employees.

 

In this Article:

 

What Qualifies as a Tip?

Per the IRS, tips include:

  • Cash tips that are received directly from customers.
  • Tips from customers who leave a tip through electronic settlement or payment. This includes a credit card, debit card, gift card, or any other electronic payment method.
  • The value of any noncash tips, such as tickets or other items of value.
  • Tip amounts received from other employees that are paid out through tip pools or tip splitting, or other formal or informal tip-sharing arrangements.

 

Four factors are used to determine whether a payment qualifies as a tip. Normally, all four must apply. To be a tip:

  • The payment must be made free from compulsion.
  • The customer must have the unrestricted right to determine the amount.
  • The payment should not be the subject of negotiations or dictated by employer policy; and
  • Generally, the customer has the right to determine who receives the payment.

 

If any one of these doesn’t apply, the payment is likely a service charge.

 

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What Are Service Charges?

Per the IRS, service charges are the amounts that an employer requires a customer to pay for services. This is true even if the employer or employee calls the payment a tip or gratuity.

 

Examples of service charges commonly added to a customer's check include:

  • Large dining party automatic gratuity
  • Banquet event fee
  • Cruise trip package fee
  • Hotel room service charge
  • Bottle service charge (nightclubs, restaurants)

 

Generally, service charges are reported as non-tip wages paid to the employee. Some employers keep a portion of the service charges. Only the amounts distributed to employees are non-tip wages to those employees.

 

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How Are Payments Tracked in Toast Payroll?

Both tips and service charges are subject to employer taxes. Note that employers are required to pay strict attention to tracking tipped income. In Toast Payroll, these payments are tracked via payroll reports like the Per Pay Period Employee Audit Report and the Quarterly Employee Payroll Audit Report. To best help employers track tips, Toast Payroll offers the FICA Tip Credit Report. All of these reports are available in the Report Library.

 

Note: Service charges are taxed the same as regular employee wages.

 

See this page from the IRS for more information.

 

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