The IRS Issues Its Proposed Regulation on ‘No Tax on Tips’

In late September, the IRS issued its proposed regulation to help clarify the no tax on tips law. For our industry, the biggest question was how to deal with service charges and automatic gratuities added to a chit. The good news is we got that answer, and the regulation actually helps!

Under the law, a tip must be made voluntarily, without any consequence in the event of nonpayment, not subject of negotiation, and be determined solely by the payor. Thus, service charges and automatic gratuities have never qualified as tips and do not qualify for tax-exempt treatment under the new no tax on tips law.

In this new regulation, the IRS specifically reiterated its agreement with this longstanding understanding of service charges and automatic gratuities, but it provided some nuance that should help club leaders and their staffs. Under the proposed rule, if a member is expressly provided an option to disregard or modify the service charge or automatic gratuity, then payment will be seen as a voluntary tip for the purposes of the new law. How will this work at the club?

For clubs using service charges or automatic gratuities, each chit should have a new “recommended tip” line with the service charge or automatic gratuity. It is best to remove the term service charge or automatic gratuity and use the IRS’ preferred language — “recommended tip.” From there, the club must have an additional line below that tip line. This second tip line must convey to members that they may either add to, reduce or eliminate the recommended tip from the bill. Remember, you must include that the tip may be reduced to zero for this to work.

It seems that adding this language is all the IRS needs to classify the charge as a voluntary tip. Therefore, any tip left — either adding nothing to the recommended tip on that second tip line, reducing the recommended tip on that second line or adding more to the recommended tip — will mean that the member accepted the club’s recommendation and added or subtracted from it, which makes it voluntary. In the end, the key is whether members can opt out of or modify the recommended tip and this, it seems, is how to do that.

Please be aware that keeping the service charge or automatic gratuity line and having an “additional tip” line below it will not work under this regulation. If you do, the IRS will see the service charge as mandatory and anything placed on that additional tip line will be the voluntary tip. Thus, change the name to “recommended tip” and add the magic language to the second tip line. Though this does seem to be more form over substance, it’s probably best to follow the IRS’ lead on this.

While this proposed rule is just that — proposed, it is unlikely we will see too many changes when it is finalized, which should be by the end of this year. As such, clubs with service charges or automatic gratuities should begin making these alterations to their chits now and ensure their members and staffs understand the new process approved by the IRS.

As always, I’m happy to help you or your team if there are questions. I’ll also be covering this topic at my session, “Navigating Washington’s New Reality: Club Industry Insights for 2025 and Beyond” at the upcoming HFTP Annual Convention on October 22-24 in Orlando, Fla. Cheers!

 Brad Steele

Brad Steele, JD is the founder of Private Club Consultants. He has been an integral part of the private club industry for nearly 15 years. He started Private Club Consultants to provide in-depth legal and operational answers for America’s top private clubs. Over the years, Brad has become the go-to resource for the private club industry on protecting private and tax-exempt status as well as many other legal issues. Connect with Brad on LinkedIn.