Law and Suggestions with Respect to Service Charges by Restaurants and Hotels to Customers

Issues: 

1. Whether a gratuity or service charge is a compulsory charge that the customer must pay.  
2. Whether a gratuity or service charge is property of the Employer or the Employee.  

Analysis  

Must a customer pay the service charge? 

The trending practice in restaurants of charging a fixed percentage at the end of each bill has been met with pushback by customers. What customers may not recognize is that the charge is beneficial to customers because it keeps food costs reasonable. As the cost of food, labor, and supplies rise, it is hard for restaurants to stay profitable while also keeping their menu prices reasonable. One-way restaurants keep food costs reasonable, by applying a service charge to offset the increasing costs of maintaining a restaurant.  

It is important for restaurant owners and hoteliers to understand the law surrounding the issue, so when pushback from their customers arises, they can confidently inform their customers that the charge is mandatory.  

There are different terms to describe the practice of charging a fixed percentage amount to each check (e.g., 20% added to each bill for parties of 6 or more). For the purposes of this memorandum, the term “service charge” will be used to refer to such practice, which is the accepted term, as per the Internal Revenue Service (“IRS”) 2017 Fact Sheet.  

The 2017 IRS Fact Sheet provides guidance on the issue but uses the term “automatic gratuities,” and states that they are service charges, not voluntary tips. A required amount that a customer must pay is a service charge. Thus, the real issue lies between a service charge and a voluntary tip and the laws surrounding the two may provide some clarity.  

Under Pennsylvania law, voluntary tips are monies received by an employee from a customer for services rendered. The monies received from a voluntary tip belong to the employee, and is an amount wholly determined by the customer. In contrast, the definition of a service charge is a mandatory fee that an employer may charge to a customer for services that an employee renders. The difference being that a service charge is a fee imposed by the employer on the customer.  

To further clarify the difference between service charge and voluntary tip, the Fair Labor Standards Act (“FLSA”), provides an example of amounts not received as tips, as a compulsory charge imposed on a customer. Even if the monies are distributed by the employer to the employee, it is not counted as a tip. Additionally, under the FLSA in its provision to define “tip” the Legislature specifically added the following “[i]t is to be distinguished from payment of a charge, if any, made for the service.” The key difference under the FLSA is a tip is a voluntary charge rather than a charge imposed by the employer to the customer, which is a service charge. Similar to Pennsylvania’s law the FLSA distinguishes a voluntary tip from a service charge by defining it as an amount wholly within control of the customer.  

Both Federal and state law view a voluntary tip as an optional charge subject to the control of the customer. A service charge is a compulsory charge that the customer must pay, because it is a mandatory fee imposed by the employer. Even though the customer must pay the charge, it is important that employers are providing notice clearly to customer to reduce confusion and in accordance with the Commonwealth’s Unfair Trade Practices and Consumer Protect Law (“UTPCPL”).  

     Compliance  

Under the UTPCPL, the Commonwealth prohibits “unfair or deceptive acts or practices,” which includes any practice of deceptive conduct that creates a likelihood of confusion or misunderstanding. It is important that employers are clear and concise regarding what fees they are charging customers. Recently discussed in Shumaker Williams, P.C. Educational Memorandum “Law and Suggestions with Respect to Charging and Disclosing Credit Card Fees by Restaurants and Hotels to Customers” was how customers should be informed of prices regarding surcharges. Similarly, to avoid confusion and to provide notice, a service charge should be posted on the menu with a percentage assessed and, on the receipt, reflecting the dollars and cents charged.  

Additionally, if the service charge is wholly for the employer, include language that informs customers that the charge does not include a tip to be distributed to the employee. This again clearly informs customers of the charge and clarifies that the charge is not to benefit the employee in connection with the service provided.  

To whom does the service charge belong to? 

It is had been settled in the United States Court of Appeals for the Third Circuit, that a service charge is property of an employer when the employee receives a wage above minimum wage, and the employer does not claim tip credit.  

For employers that do claim tip credit for employees the issue is more muddled. Under Pennsylvania’s Minimum Wage Act (“PMWA”) definition of “wage” for tip credit employees, provides “where the gratuity is added to the charge made by the establishment, either by the management, or by the customer, the gratuity shall become the property of the employee.” This creates confusion between employers and employees about who owns the monies from a fixed fee. Without any guidance from the Commonwealth, it is up to employers to communicate clearly to employees as to the purpose of the service charge. This can be accomplished by sending out notices to employees, including same in Employee Manual, or for new hires by informing them of the practice when providing them with notice of the tip credit.  

Additionally, it creates ambiguity when an establishment charges customers a “mandatory gratuity” because the term gratuity is generally associated with money paid to employees. Since the PMWA states gratuity added by either management or customer is property of the employee, if an employer does not disburse the entire monies collected from the “mandatory gratuity,” it may become a Department of Labor issue. 

 It is our recommendation that a restaurant or hotel wanting to charge a service charge to exclude using the term “gratuity” to reduce confusion with employees or customers as to whom the service charge benefits.  

Conclusion  

Everyone is feeling the effects of inflation, and businesses are under presses to keep reasonable prices. If an establishment is thinking about charging a service charge to customers or patrons, providing notice on menus and on receipts (with dollars and cents), may limit legal exposure. Additionally, establishments need to be clear that this is not a gratuity nor a replacement of a tip for your service to the employee.

The information contained herein is provided for general informational purposes only and may not reflect the current law in your jurisdiction. No information contained in this blog should be construed as legal advice from Shumaker Williams P.C. or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter. This blog is current as of the date of original publication.