Service Charges vs Tips: Stop Hidden Wage Mistakes

If you’ve ever looked at a paycheck and wondered why some money counted toward your wages while other amounts didn’t, you’re not alone. In hospitality and services, “service charges” and “tips” show up everywhere—on receipts, banquet event orders, room service, delivery apps, and even salon invoices. They look similar to customers, but under wage-and-hour rules they are legally different, and that difference can change your base pay, overtime rate, and eligibility for tip pooling. This guide breaks it down in plain English so workers, managers, and owners can set policies that are both fair and compliant.

What’s the legal difference between a service charge and a tip?

Tips: voluntary, customer-driven

A tip (gratuity) is a voluntary amount a customer leaves for a worker. The customer has the unfettered right to determine the amount and the recipient. Generally, tips belong to the employee, not the employer. Employers can sometimes take a tip credit toward the required cash minimum wage if certain conditions are met (clear notice, tip retention, role eligibility, and more).

Service charges: mandatory, house-controlled

A service charge is not voluntary. It’s a compulsory fee—for example, a 20% banquet fee automatically added to the invoice. Because the customer doesn’t control the amount or the recipient, it’s typically considered employer revenue. The employer may distribute it to employees as wages or bonuses, but it generally does not qualify as a “tip” and therefore doesn’t support a tip credit unless state/local law expressly says otherwise.

How each affects minimum wage, tip credits, and the regular rate

Minimum wage and the tip credit

Employers in certain jurisdictions may count tips toward the minimum wage via a tip credit, but only if they meet strict notice and role requirements and ensure that employees retain their tips. If they do not meet the conditions, the employer must pay the full cash minimum wage without using a tip credit. Service charges, by contrast, generally cannot be used as “tips” for a tip credit. If distributed, they are treated as wages paid by the employer.

Regular rate and overtime

Overtime is based on an employee’s regular rate, which includes almost all remuneration for employment. When a business pays out service charges to employees, those amounts typically count toward the regular rate, increasing overtime pay. True tips given by customers are generally excluded, but employer-paid bonuses or mandatory charges usually are included. Misclassifying a service charge as a tip can lead to underpaid overtime.

Pooling, managers, and who can share

With tips, only eligible, tipped employees may participate in a valid tip pool (and managers/supervisors are typically excluded). Because service charges are employer funds, the business can decide how to distribute them—but that distribution becomes part of wages, and the employer must still follow all recordkeeping, notice, and overtime rules.

Policy design: how to name, disclose, and pay correctly

Clear labels on menus, contracts, and receipts

Use unmistakable language. If it’s a service charge, label it as such: “A 15% service charge will be added to all checks; this is a house fee used to support wages and operations.” If you intend to distribute all or a portion to employees, say so in plain English, and reflect it on pay statements.

Written tip policy and legally compliant notice

When using a tip credit, provide the required written notice to tipped employees before it takes effect. Specify the cash wage, the credit amount, and that employees keep their tips. Keep copies, acknowledgment receipts, and ensure the policy matches what happens in practice.

Banquet and events: pre-contract clarity

For banquets, weddings, and conferences, disclose whether the fee is a service charge or a gratuity. Customers frequently assume “gratuity included” means tips for the staff. Mislabeling drives disputes and can spark wage claims from employees who expected to receive the amount.

Advanced: regular rate math and overtime examples

Scenario A — true tips with a valid tip credit

A server receives $200 in true tips during the week. The employer takes a valid tip credit and pays the required cash wage. Those customer-paid tips generally do not count toward the regular rate. Overtime is calculated on the cash wage plus any nondiscretionary amounts the employer pays.

Scenario B — 18% “service charge” distributed to staff

A restaurant adds an 18% mandatory fee and allocates a portion to servers. Because the fee is not voluntary, those amounts are employer-paid wages. They increase the regular rate and therefore the overtime premium. If the business mislabels this as “tips,” it risks underpaying overtime and violating notice rules.

Step-by-step: set a compliant policy and payroll flow

1) Decide: tip system, service charge, or both?

• Tip-only: customer voluntary tips; possible tip credit if legally allowed and notices are in place.
• Service charge-only: mandatory fee; distributed amounts treated as wages; no tip credit reliance.
• Hybrid: both exist; requires crystal-clear labels, separate accounting, and careful overtime math.

2) Write plain-language disclosures

• Menus, contracts, and receipts must distinguish tips from service charges.
• If you distribute service charges, say so and note that they are treated as wages.
• If using a tip credit, include all required elements in the employee notice.

3) Configure POS and payroll codes

• Separate tender types: Tip vs. Service Charge.
• Map service charge distributions to taxable wages included in the regular rate.
• Keep distinct reports for reconciliation and audits.

4) Train managers on do’s and don’ts

• Do not let supervisors share in tips.
• Do not relabel service charges as “gratuity” on the receipt to boost sales.
• Maintain accurate timekeeping and ensure overtime reflects the true regular rate.

Conclusion — pay fairly, label clearly, and avoid overtime traps

The fastest route to compliance is also the simplest: tell customers the truth, tell employees the rules, and code your payroll correctly. Tips are customer-controlled and belong to employees; service charges are employer-controlled and, when distributed, become wages that affect the regular rate and overtime. Label everything, document your policies, and keep tip pools clean. With those pillars in place, you protect margins and paychecks.