Tipping is a standard part of the dining experience — customers are accustomed to leaving a tip for employees at most restaurants. When it comes to service charges, however, guests have less clarity. Restaurants don’t always explain these extra fees, so patrons are often confused about what the amount covers and if it replaces a tip. If you work in the restaurant industry, it’s important to understand the distinction between these common charges.

What is a service charge at a restaurant?

A service charge is a fee that restaurants add to customers’ bills. This amount doesn’t go to the server — the business collects the money. Restaurants typically charge service fees for extra services related to the meal: delivering food, providing room service, or catering an event, for example.

Many businesses also add a mandatory service charge for large groups; it’s also called an automatic gratuity. This fee usually applies to all customers, but restaurant membership programs sometimes offer a “no service charge” perk for members.

A tip, on the other hand, is an amount of money a customer gives directly to the server. Guests may leave cash tips or add noncash tips to their credit card receipts. Tipping helps make up for the low minimum hourly wage for restaurant workers. As of 2023, the Fair Labor Standards Act (FLSA) grants tipped employees a minimum wage of just $2.13 per hour. If servers’ regular wages plus tipped wages don’t equal the standard federal hourly minimum wage of $7.25, the business owner must make up the difference when distributing payroll.

It’s important to note that individual service personnel don’t always get to keep the entire tip amount. Some restaurants use tip pooling, where all tips go into a tip pool before getting divided among the staff. Employers may also take a tip credit to count part of an employee’s cash tips against the business’ minimum wage obligations.

Service charge vs. tip

The main difference between these two fees? A service charge is mandatory, and a tip is at the discretion of the customer. Technically, tipping is optional — but some customers might argue otherwise, given that tip income is critical for the service staff.

Restaurants have different rights and responsibilities when it comes to tips and service charges. In most states, employers can keep the entire service charge and use it as they please. When it comes to tips, restaurants aren’t allowed to take any of the money; they may, however, pool it and redistribute it among tipped employees. The arrangement they choose affects payroll practices, restaurant accounting procedures, and the way employees and employers report tips to the Internal Revenue Service (IRS).

How to manage service charges

Implementing service charges can help you cover the expenses of operating a food-service business. Some restaurant owners use the extra income to offset rising costs due to inflation or higher credit card fees. You might also pass a percentage on to your staff in the form of bonuses, raises, or better benefits.

Every establishment is different; the service charges you choose should suit the needs of your restaurant. As you develop a strategy, keep these tips in mind: 

• Create a standard service charge model. Set a flat fee for every service charge. You might charge $2.50 for every delivery, for example, or use an automatic gratuity of 20% for groups of 9 people or more. In doing so, you’ll ensure every customer is charged fairly.
• Communicate service charges clearly. List each fee on your menu, website, and online ordering portal so customers know exactly what to expect. Whenever possible, explain that the service charge isn’t a gratuity. That way, you can protect employees from uncomfortable confrontations when the bill comes.
• Be transparent about how service fees are used. Make sure employees understand exactly how each fee is used so they can explain it to guests.
• Understand state laws regarding service charges. Some states have specific laws about how you can use service charges. In Massachusetts, for example, service charges can only be levied in lieu of a tip. You must give the money to the employees who would typically get the tips. If you want to charge an additional administrative or house fee, you must state clearly that it’s not a tip and won’t go to the employee.

If you decide to use service charges, it will likely affect your taxes. Tips and service fees are treated differently by the IRS. How you use the money matters, too. Thinking of giving part of the service charge to your employees? The IRS requires you to report it as non-tip wages, which means you’ll need to withhold payroll taxes, including Social Security and Medicare tax.

Service charge FAQs

Can an employer keep service charges, or must they be distributed to employees?

In most cases, restaurant owners can keep the service charge. In some areas, however, state law has specific rules for how you can use the money.

What if a restaurant employer violates local ordinances by keeping the service fee?

The consequences of violating local or state laws regarding service fees vary by region. If a restaurant employer is caught going against regulations, the civil and criminal penalties will be determined by local and state law.

Service charges can be a useful way to increase your restaurant income or cover extra expenses. Before you implement a new charge, make sure to research the state laws, tax implications, and potential customer impact.Want more helpful restaurant tips and tricks? At Grubhub, we’re proud to provide our partners with the latest industry updates and useful information — our goal is to help you reach more customers, retain loyal employees, and provide top-notch service. To see how we can help you build a stronger restaurant business, try out Grubhub today.