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Service Charge vs. Tip: Who Gets the Money, and Why It Matters

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Quick answer: A tip is money the guest chooses to leave, in an amount they decide. A service charge is a fee the restaurant adds, like an automatic 18% gratuity for a big party, and it's the restaurant's money. Under federal law the restaurant can keep all or part of it; whatever it pays you from it is wages, taxed like your hourly pay, and it doesn't count for the No Tax on Tips deduction. Some states, including Massachusetts, New York, Hawaii and Minnesota, make it go to the staff unless guests are clearly told otherwise, and others make restaurants say how it's split.

You've seen it on a party of ten: “Gratuity 18%, added for parties of 6 or more.” The guests think they've tipped. You think you've been tipped. The IRS says neither of you is right. That 18% is a service charge, and it's the restaurant's money until the restaurant decides otherwise.

It's worth knowing, because service charges are spreading well past big parties: a 20% charge on every check in place of tipping, a 3% “kitchen appreciation” fee, a surcharge for staff health insurance. Square found that in the second quarter of 2024, about 3.7% of restaurant payments on its system included a service fee, more than double the share at the start of 2022. Some restaurants pass every cent to the staff. Some keep part. Some keep all of it, and federal law lets them. Here's how to tell a tip from a service charge, where each one goes, and what it does to your taxes.

What makes a tip a tip

The IRS spelled out its test in a 2012 ruling, and it has four parts. A payment is a tip only if:

  1. The guest pays it freely. Nobody makes them.
  2. The guest decides how much, including nothing at all.
  3. It isn't negotiated or set by the restaurant's policy.
  4. The guest generally decides who gets it.

Miss any one and it's probably a service charge, whatever the check calls it. The IRS's own example is the big-party gratuity: an 18% charge a restaurant adds to every table of six or more isn't paid freely, so it's a service charge, not a tip. Anything the guest adds on top of it, on an extra tip line, is a tip.

A made-up check for a party of 8: dinner $152.00 and drinks $28.00, a $180.00 subtotal, an 18% gratuity for parties of 6 or more of $32.40 and a 3% kitchen fee of $5.40, a total of $217.80, and a $10.00 extra tip written in by hand, $227.80 paid. Only the $10.00 the guest wrote in is a tip. The gratuity and the kitchen fee are service charges, because the guest had to pay them.
The test in practice: if the guest couldn't leave it off, it isn't a tip.

When a charge on the check is still a tip

Where the money goes

Two paths for the same $36 on a $180 check. A $36 tip: the guest chooses it; it is yours, apart from a legal tip pool or tip-out; you report it to your employer as tips; it is on your W-2 as tips, in box 7 and box 12 with code TP; and it counts for No Tax on Tips. A $36 service charge: the restaurant adds it and the guest has to pay it; it is the restaurant’s money, which federal law lets it keep, though some states don’t; what it pays you is wages, taxed like your hourly pay; it is on your W-2 as wages, not in the tip boxes; and it does not count for No Tax on Tips.
Same $36, same table, two different kinds of money.

A tip belongs to you. Federal law bars your employer, its managers and its supervisors from keeping any part of it; the only things that can come out are a legal tip pool or tip-out and the card company's actual fee on a card tip. (The details are in can your employer take your tips?)

A service charge is part of the restaurant's sales. In the IRS's words, an employer “may distribute service charges or auto-gratuities to employees in any manner it chooses or may retain all or part.” So it can keep the money, use it to pay the kitchen, or pass it to the servers, unless your state says otherwise (more on that below). Whatever it passes to you is wages, and that changes three things:

Tip vs. service charge, side by side

TipService charge
Who sets the amountThe guestThe restaurant
Whose money it isYours, apart from a legal tip poolThe restaurant's, unless your state says otherwise
Can a manager keep it?NeverFederal law allows it
You report it to your employerYes, every monthNo, it's already in your pay
TaxesIncome tax, Social Security and MedicareThe same, withheld from your check
On your W-2Box 7 and box 12, code TPIn your wages, not the tip boxes
Counts toward overtimeNoYes
No Tax on Tips deductionCountsDoesn't count

Why it matters for your taxes

The No Tax on Tips deduction lets you take up to $25,000 of reported tips a year off your federal taxable income, from 2025 through 2028. It covers tips only. The law defines a qualified tip as one “paid voluntarily without any consequence in the event of nonpayment,” and the IRS's final rules, issued in April 2026, spell it out: service charges, automatic gratuities and any other mandatory amounts added to a bill “are not qualified tips, even if the amounts are subsequently distributed to employees.”

So the same $36 is worth more to you as a tip than as a service charge. Say $6,000 of your year came from big-party gratuities. As tips, that $6,000 could come off your taxable income; as service charge pay it can't, which at the 12% tax bracket is about $720 more in federal income tax. A server at a restaurant that puts a service charge on every check, and where guests rarely tip on top, may have almost nothing to deduct.

Two more effects. You don't report service charges to your employer as tips, because they're already in your wages; the IRS tells servers to leave them out of their daily tip record. And your W-2 keeps them apart: box 7 and box 12 with code TP show the tips you reported, while service charge pay is counted with your wages. Our guide to W-2 box 12 code TP explains those boxes.

States that make restaurants share it or explain it

Federal law is only the floor. Twelve states and D.C. have rules of their own, of three kinds.

Tile map of the United States showing states with their own rules on restaurant service charges. A service charge belongs to the staff by default, unless guests are clearly told otherwise (in Montana, always), in Delaware, Hawaii, Maine, Massachusetts, Minnesota, Montana and New York. The restaurant must say how the service charge is split in Colorado, District of Columbia, Michigan and Washington. California and Florida require a mandatory charge and its purpose to be shown with the prices. Every other state follows federal rules, which let the restaurant keep the service charge; Pennsylvania adds a rule for banquets only.
Thirteen places with rules of their own, each explained below.

It belongs to the staff, unless guests are told otherwise

The restaurant must say how it's split

It must be shown with the prices

Elsewhere, and in cities

Pennsylvania has a narrower rule for banquets and special events: an administrative charge must be disclosed as not a tip, and the bill must show service charges and tips on separate lines. Rhode Island's law says outright what federal law implies: service charges are the employer's money, not tips.

Cities can add their own. Since April 2026, New York City lets a restaurant add a mandatory gratuity only when it's disclosed clearly and all of it goes to the staff under a written agreement, such as a union contract. Los Angeles hotels must pay service charges in full to the workers who did the service, and Oakland's hospitality employers must pay them to the employees who served.

One thing state law doesn't change: your taxes. Even where a state says the service charge belongs to the staff, the IRS still treats a charge the guest had to pay as a service charge. It's wages on your W-2, and it doesn't count for No Tax on Tips. These are summaries; your state's labor department can tell you how its rule applies to you.

Kitchen fees, health fees and other names

A “kitchen appreciation fee,” a “wellness surcharge,” a “living wage fee” or an “admin fee” is a service charge in the eyes of federal law if the guest has to pay it. It isn't a tip for anyone, and federal law leaves it to the restaurant. Where it can get the restaurant in trouble is state law: in Massachusetts a fee guests would reasonably think goes to the staff has to go to the staff unless the restaurant says otherwise, and in New York a charge for “service” is presumed to be a gratuity. A card surcharge, which covers the restaurant's card fees, isn't money for the staff at all.

What to do at your restaurant

Tracking tips when your checks have service charges

The Tips section of Tip’d's Log a shift form, from a made-up shift: Cash $84 and Card $212, with the hint Fill in either or both.
Tip’d's Tips fields, from a made-up shift: they're for what guests chose to leave.

In Tip’d, the tip tracker we make for iPhone, the Cash and Card fields are for tips: what guests chose to leave, including anything added on top of a service charge. Leave the service charge out of them and write it in the shift's note instead (“party of 12, 18% auto-grat, $64”). That keeps your logged tips matching what you report to your employer, keeps the No tax on tips card on the Year screen counting only tips that can qualify, and gives you a list of service charges to check against your pay stub. Logging shifts is free, with no ads and no account.

Questions people ask

Is an automatic gratuity a tip?

No. If the restaurant adds it and the guest can't take it off or change it, it's a service charge, even when the check calls it a gratuity.

Can my restaurant keep the service charge?

Under federal law, yes, all or part of it. In Delaware, Hawaii, Maine, Massachusetts, Minnesota and New York it belongs to the staff unless the restaurant clearly tells guests otherwise, and in Montana it must go to the staff. Colorado, D.C., Michigan and Washington make restaurants say how it's split. The map above shows them all.

A guest added a tip on top of the service charge. Is that mine?

Yes. Anything a guest chooses to leave on top of a service charge is a tip, with every protection a tip has, and it counts for No Tax on Tips.

Do I report service charges as tips?

No. Service charge pay is already in your wages. Report only what guests chose to leave; here's how to report your tips.

Can service charge pay count toward my minimum wage?

Under federal law, yes, all of it. In Washington and Michigan it can't: service charge pay there comes on top of the wages you're owed.

Our card reader won't let guests choose no tip. Are those tips?

Only the part above the minimum the screen forces counts as a tip for No Tax on Tips. The IRS treats a required minimum as a mandatory charge.

Is this legal or tax advice?

It's a plain-language summary of federal and state rules as of October 2026. Your state's labor department, a lawyer or your tax preparer knows your situation; this guide doesn't.

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