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Tips, Gratuity and Service Charges

Explore the legal, tax and operational aspects of collecting gratuities with Dine.Direct in California

There are both federal and state restaurant labor laws in place that assures the rights of people employed in the foodservice industry. This article is specific to restaurants in California and may not be applicable to restaurants in other states.


Tips vs Service Charges

This extra money left by a customer is classified into one of two categories. It will either be non-taxable "tip" or a taxable "service charge".

"Tips" and "Service Charges" are treated differently from a sales tax and payroll tax perspective. 

  • In California, restaurants do not have to collect sales tax on "tips". They do have to collect sales tax on "Service Charges".
  • In California, it is the worker's responsibility to report "tips" on their income taxes. "Service Charges" must be treated by the restaurant as payroll.

Working out the math, tips are WAY better than service charges. In a dine-in setting, if a customer slips a server $10, they keep the $10 (and then responsibly self-report on their tax returns). With a "Service Charge", the restaurant has to peel off about $0.77 of tax and then take the remaining $9.23 and add it to the server's normal payroll.  After state and federal taxes your server is lucky to see $6.

From this math, tips are way better.

When a Tip is not a Tip:

Sadly the legal category this money falls into has nothing to do with what you call it on your receipt. Just calling something a "tip" does not make it a tip - just like calling a double pepperoni pizza a garden salad won't really help your cholesterol go down.

So, if the name doesn't matter, how can you tell the difference between a tip and a service charge?

Well, the nice folks at the Department of Labor have actually made this classification pretty easy. They basically say that "tips" have to meet several criteria. We are going to touch on a couple of important ones that relate to Dine.Direct.  Here we go. :)

  • Tips must be completely voluntary. If you force your customer to leave even $0.01 then whatever amount they choose to leave is classified as a service charge.
  • The customer must be able to designate how the tip is allocated.  If you force a tip given to a server to be split with your kitchen then it's technically not a tip. If your server chooses to share it, this is their choice. The point here is, the restaurant does not have control of the cash. If the restaurant takes control of the cash, it's a service charge.

Tips with Dine.Direct

If you are using GrubHub or one of the other food tech companies, you never think about this because you never touch this money anyway. They keep it all. But with Dine.Direct, you have control of this extra money.

Dine.Direct is designed to pre-collect the tip during the order process. No cash involved, no COVID, touchless delivery. 

So, you now have this money in your bank account. What are you going to do with it? There is no "server" to give the money to. Your Dine.Direct avatar takes care of the entire ordering and customer communication process. You could:

  • Give it all to the driver?
  • Split it with your kitchen and expo?
  • Cover the cost of delivery and split the rest?

With Dine.Direct, you have control of this money, which kind of violates one of the legal definitions of a "tip".  The gratuity that you collect during payment with Dine.Direct is most likely a "Service Charge".  So our suggestion is to pay sales tax on it and treat it like a "Service Charge".  Then you can take some or all to cover your costs and share the rest with your staff as a little extra bonus in their regular salary.

In the real world

Bleu Boheme (our first client in San Diego) worked all of this out with our Dine.Direct partner Flores Financial. Usually, Bleu Boheme does self-delivery and they give the driver 60% and the back of the house 40%. They treat everything like a service charge.  On the days their staff is busy, they use Postmates DOS and pay the $7 delivery fee. With Postmates the restaurant keeps the money to cover the delivery and then splits the rest with the kitchen and expo. That's their secret to offering "Free Neighborhood Delivery".


If you still have questions or want more specific accounting guidance please contact our Dine.Direct partner Flores Financial. They keep hundreds of restaurants in compliance all over Southern California and would be delighted to help you.

Flores Financial