Service Charge vs Tip: What Restaurant Owners Need to Know

Service charges are fixed fees added to customers’ bills, while tips are voluntary payments customers make to employees. Many restaurant owners must decide whether to employ service charges or tips, but both may have a place in their operations.

Read on for the pros and cons of restaurant service charges vs tips, when it makes sense to employ one over the other, and how the question of tipping and service charges became such a hot-button issue for restaurant customers and staff.

What Is a Service Charge at a Restaurant? 

A service charge is not a tip; it is a fee added to customers’ bills to cover any type of cost, including staff wages, operational costs, and food and supply chain expenses. Many independent restaurant owners have employed service charges to offset rising costs of goods and utilities, labor, and employee benefits, as well as to boost profits. 
Service charges are mandatory, predetermined, and the property of the restaurant to use however they see fit. Fees typically range between 3% to 20% of the total bill.

Types of Restaurant Service Charges

There are many types of service charges that a restaurant might charge, depending on the restaurant type. The most common service charges are as follows:

• Auto-gratuities: This is not a tip or a gratuity; it is recommended not to use this confusing language at all. An automatic gratuity is a service charge in disguise—the money received goes directly to the house.
• Large party gratuity: A fee of at least 18% is added to groups of six or more people. Customers should be told that this fee is added—they don’t always see it when splitting the bill and often tip more on top of the gratuity.
• Administrative fee: An administrative fee is a common addition to a catering or special event contract. This fee usually ranges from 3% to 5% and is typically awarded to the catering or special event salesperson who sold the package and handled the contract. 
• Room rental fee: If you have a private dining room or close off sections of your dining room to accommodate private parties, you might charge a room rental fee to cover the additional expenses that private parties can incur. These costs might cover additional staff or the loss of revenue from being unable to turn tables. 
• Benefit fees: Some business owners charge fees to cover employees’ healthcare, 401K, paid time off, and training. Benefits aren’t always easily available to restaurant employees, but they will give you a leg up when hiring and retaining quality staff members. 
• Holiday charge: This fee covers worker holiday pay when guests dine during Thanksgiving, Christmas, or New Year’s. Customers can decide whether or not to waive this fee. A workaround would be to offer a prix fixe menu on these holidays, with the fee worked into the price of the meals. 
• Supply chain fee: Some restaurants have begun charging a 10% supply chain fee because of the fluctuation in supply prices since the pandemic.
• Delivery driver fees: Third-party delivery fees from companies like Uber Eats and Grubhub tack on delivery fees and add fees to each individual menu item for the customer. They also charge the restaurant fees for the service.

Optional fees are fees that must be disclosed to the guests before they incur them, giving them the opportunity to turn them down.

• Corkage fee: A corkage fee is a fee charged when customers bring their own bottle of wine to a restaurant. The charge covers the use of the table and glassware, the service to open the bottle, and the loss of revenue to the restaurant for not buying wine from the menu. The fee is often $10 to $40 or can be upwards of $100, depending on the restaurant. Some establishments charge a flat rate, while others charge by the type of wine brought in or for a bottle of the cheapest wine on the menu.
• Cake cutting fee: A cake fee is similar to a corkage fee. It is charged when customers bring a cake into the restaurant. This fee covers the cost of lost dessert revenue and longer sitting times at the table.

What Is a Tip at a Restaurant?

According to the IRS, a tip is an optional payment that employees receive from customers, whether in cash, extra money through a credit card, debit card, gift card, Apple Pay, or any other means of electronic payment, or the value of a noncash gift like a bottle of wine or concert tickets. Tips are voluntary, not predetermined, and owned by tipped employees. 

All tips, cash or noncash, must be recorded and submitted for Federal income tax. When service charges are used as tips, the restaurant must treat the money as wages. This means that employers must deduct payroll taxes from the service charges before splitting it for their staff. 

Service Charge vs Tip: What’s Better for Restaurants? 

There are multiple reasons a restaurant might choose to rely on tips, service charges, or both. The choice between tips and service charges isn’t an either/or decision; most restaurants use some combination of both tips and service charges. What’s better for your restaurant will vary based on your restaurant style. Most restaurants rely primarily on tipping, augmented by a basic service charges (like auto-gratuities). 

Consider the pros and cons of each model to choose the best strategy for your restaurant.

Service Charges vs Tips

Best Practices for Restaurants

Whether your restaurant operates with tips, service charges, or a combination of the two, there are some guidelines you’ll want to follow. The key is to keep your managers, staff, and customers on the same page. 

Tipping Best Practices

If you decide to stick with tried and true tipping that everyone is familiar with, consider adding a guide to the bottom of the receipt with recommended percentages and their amounts. This says something along the lines of, “The recommended tip amount for your $10 meal is 15% = $1.50, 18% = $1.80, or 20% = $2.00.” This takes the math out of the equation for guests who don’t want to figure it out, especially after a few glasses of wine.

Tip-dependent restaurants should also clearly communicate their tip pool or tip out policies for all tipped staff. Read our guide to restaurant tipping methods to explore various tip sharing models. And check your local labor laws to ensure that your tip sharing policy complies with local laws before rolling it out. 

Service Charge Best Practices

If you decide to add service fees, honesty and transparency are the keys to success. You should also do the following:

• Consult your attorney: If you decide to implement service charges to your customer’s bills, the first thing to do is consult your attorney for the best way to proceed safely. A number of class action lawsuits have been filed against large restaurant groups and hotel chains for restaurant service charges and unclear practices.
• Communicate clearly: If you aren’t completely transparent, you run the risk of violating consumer protection laws prohibiting hidden fees. Let customers know why you are charging the fee and how it will be distributed. 
• Be organized: Decide what percentage to add to bills for your fee and break down where each percentage will be spent after the fees are collected. 
• Use signage: Clearly and visibly mark your new service charge with a sign and the date of implementation, ideally at the entrance to your restaurant or on the front of the menus.
• Train your team: Train hosts and hostesses to tell customers about service charges as soon as reservations are made, before phone orders, or when they’re seated. They should explain that tips are not included in the service charge. Tell your servers how to correctly respond to questions about service charges in a positive and communicative manner. 
• Update your systems: Update your point-of-sale and online ordering systems with the relevant fees to keep service moving quickly.

Controversies on Tipping

When it comes to tipping, Americans’ feelings of frustration are centered around self-service. In a survey by Toast, only 11% of people are willing to tip when ordering from a kiosk and 12% when picking up their own orders. Ordering off of a QR code menu only increases their willingness to tip to 23%. 

However, when it comes to tipping a server for traditional table service, 79% of people said they don’t mind.

Lawmakers have tried to raise the minimum wage for tipped employees in many states, believing that higher hourly wages will help build a livable foundation. This idea is challenged by tipped workers who believe they make more with a lowered hourly wage plus tips than they would with a higher hourly pay from employers.

When hourly wages are lower than minimum wage for tipped employees, most service workers still end up far surpassing the minimum wage with tips factored in. Businesses save on labor costs and are willing to staff more workers when the customers are making up the difference in pay. When the minimum wage is raised, restaurants respond by cutting employee shifts and hours. Often, owners can’t cover the extra labor costs and are forced to close the business. This leaves employees unemployed and looking for work in a crowded market. 

A study from the Employment Policies Institute found that each $1 hourly increase for tipped workers causes 6.1% employment decrease and 5.6% decrease in earnings. The study also found that tipped employees are 20% less likely to be poor than nontipped minimum wage earners. Researchers found no evidence that poverty decreased after raising the minimum wage of tipped staff.

Seven states have raised the minimum wage for tipped employees to match that of nontipped workers. Toast recorded the changes in recorded tips in these states and found that six out of the seven states that have implemented this system now have the lowest average tip percentages in the country. California has the lowest average tip rate of 18.2%, but it also has the highest wages of $15 per hour. Higher server pay leaves customers feeling that they don’t need to tip as much to cover the cost of employment, but with shorter and fewer shifts, servers are left with less overall take-home pay. 

Restaurant Employee Sentiment on Tipping vs Service Charges 

We looked at sentiments from servers and business owners on Reddit.

The general consensus among servers about service charges is disdain. Servers believe that they would make more money with lowered hourly wages and tips. They often feel that the practice isn’t transparent enough, they don’t want to share service charges with restaurant owners, and customers end up confused and don’t tip as much. Service members are often left wondering where all the extra money goes and feel that it’s unfair to their bottom line. 

For business owners, service charges are more complicated. Laws vary by state, and they are left to handle angry servers and customers. Owners show concern that if they go to a tipless model, they are likely to lose their staff and be unable to gain qualified new candidates because of the loss of wages. Some owners have had great success with a tip-pooling model between the front and back of the house. A lot depends on server expectations—if they’re hired on with the expectation that this is how it’s run, they’re more likely to stay. On the flip side, if they go from making $150 per night in tips to $75, they’ll most likely become resentful and leave. 

Experienced servers expect to make more than the back of the house because, historically, they do, but most know that the cooks have a very difficult job. A lot of them attended expensive culinary schools with steep student loans and they work hard in hot and stressful situations to crank out good food for the servers to bank on. One chef-turned-owner makes sure to pay his kitchen staff a comparable amount to what the service staff makes to retain them and treat them right. 

Another man worked at a restaurant where servers were required to tip 5% of their total sales to the back of the house. In return, the cooks would help with sidework, stocking, and bussing tables, in addition to their other duties. This job shift reclassified their positions to legally be able to accept tips. This was legal in the state of Washington and created an even playing field for all of the staff to make similar amounts. This model was not well received by the Reddit serving crowd, but it creates a fair workplace for everyone involved.

Also Read: Creating a Positive Restaurant Culture (+ 6 Expert Tips)

Frequently Asked Questions (FAQs)

These are some common questions we encounter about restaurant service charges vs tips.

Last Bite

Whatever you decide for your restaurant between service charges vs tips, the key is to find the best solution for you, your staff, and your customers. Service charges are a new concept and are often controversial. They can also help create benefits and a more financially balanced workplace between the front and back of the house staff. The key to making them work is transparency by managing expectations for customers and staff.

A traditional tip model is comfortable for staff and guests as they know what to expect and are familiar with it, but it can leave gaps in funding for rising costs of business, benefits, and back-of-the-house wages.

Give it some thought, do your research, and decide what’s best for your business.