Tennessee mandatory gratuity and sales tax: why it is taxed

Tennessee treats a charge that the seller adds to a restaurant check as mandatory and part of the taxable price, whether the seller calls it a tip, a gratuity, a service charge or something else. The state's rule on tips, gratuities and service charges treats a charge the seller adds as mandatory, whatever the seller calls it. A tip the guest chooses and writes in is voluntary and is not taxed.

What does the Tennessee rule say?

The Department of Revenue's sales and use tax rule on tips, gratuities and service charges, rule 1320-05-01-.76,The Department of Revenue's sales and use tax rule on tips, gratuities and service charges, rule 1320-05-01-.76, is the rule to read. Its key point is that a charge the seller adds is mandatory whether the seller styles it as a tip, gratuity or otherwise. The label does not change the tax. If you think a particular charge should be treated differently, ask the Department for a written ruling before you rely on that view, and read the current text of the rule, not a summary.

Is a voluntary tip taxable?

No. A voluntary tip, where the guest decides whether to leave one and how much, is not part of the price and is not taxed. The tip line on a card slip or a blank on a check is voluntary. The difference is who decides: the guest or the business.

What counts as added by the seller?

An 18 percent charge for parties of eight, an automatic gratuity on every check or a service charge for private dining is added by the seller. So is a charge that is pre-filled on a tip screen and cannot be changed. If the guest has no real choice, treat the charge as mandatory, taxable and part of the price. A suggested tip that the guest can change or remove is different, but make sure the screen lets them do it.

Can a charge ever be treated as voluntary?

The safe approach is to charge sales tax on any amount you add to the check. A charge that is truly the guest's choice, which the guest can change or remove without any pressure, is a tip and not a charge you added. If you believe you have a real case that a charge you add is voluntary, ask the Department of Revenue for a ruling in writing first, and keep the answer.

A worked example for a party of ten

A party of ten orders $400 of food and drink. Your policy adds an 18 percent gratuity, which is $72, and the check shows it as a gratuity line. Under the Tennessee rule, the $72 is part of the taxable price, so tax applies to $472, not $400. If the combined tax were 9 percent, an invented rate used only for the arithmetic, the tax would be $42.48 on $472 and not $36.00 on $400, a difference of $6.48. The $72 still goes to the servers as a gratuity, but the tax is owed on it. The same party leaving a $72 voluntary tip would produce no tax on the tip.

How do you set up the check?

1. Decide whether the charge is automatic or voluntary.
2. If automatic, include it in the taxable amount and calculate tax on it.
3. Show the charge on its own line with a clear label.
4. Say on the menu when it applies and what it is.
5. Pay it to staff as your policy says, through payroll.

What if you prefer a voluntary tip?

A restaurant can rely on a voluntary tip for small parties and use a suggested tip line for large ones. A voluntary tip avoids the tax question, and the guests keep the choice. If you want certainty for a very large party, tell the party in advance about the policy, and make it a conversation rather than a surprise.

What about the labor rules?

Tax and wages are separate questions. Tennessee also has a labor law provision on how mandatory service charges and tips may be distributed, which is covered in the tip pooling guide. That guide on tip pooling and service charges covers the pay side, so read it before you decide how to pay the money out.

What should you do before you rely on this?

Read the current rule on the Secretary of State's site or the Department's page, and ask your accountant to check your check template. Keep a dated copy of the rule you used. Rules can be amended, so confirm that the text you read is current.

How do you explain it to a large party?

Tell the party at booking that an 18 percent gratuity is added for parties of eight or more, that sales tax applies to it, and that it goes to the service team. A guest who hears the tax treatment in advance is less likely to object at the table. Put the same wording on the menu and the confirmation, and make sure the check shows the gratuity and the tax as separate lines, so the guest can see how the total is built. Brief servers to give the explanation in one sentence and to call a manager if the guest wants to discuss it.

More guides for your business:

• Tennessee tip pooling and service charge law for restaurants
• Tennessee credit card surcharge rules for restaurants
• Tennessee gift card rules for restaurants

More in the US guides for food businesses.