The Independent Restaurant Coalition believes all restaurant workers should be treated equally under the tax code.
In July 2025, Congress enacted a federal deduction for tipped income as part of the One Big Beautiful Bill Act. In April 2026, the Internal Revenue Service finalized the regulations implementing it. Those regulations apply only to tips a customer leaves voluntarily. Mandatory service charges and automatic gratuities do not qualify, regardless of how the revenue is distributed or which employees receive it.
This distinction carries significant consequences for independent restaurants. A growing number of operators have adopted service charge models specifically to distribute revenue across their entire staff, including the cooks, dishwashers, and prep workers that customary tipping does not reach. These models are among the most effective tools available to raise compensation for the lowest-paid, back-of-house positions in the industry. Federal tax policy now disadvantages the restaurants that have adopted them.
The result is an inequity between similar workers at similar businesses. Two restaurants on the same block, providing their employees the same total compensation, are treated differently under federal law. The restaurant that retains customary tipping gets a higher bang for its buck under the tax code. The restaurant that adopted a service charge to raise kitchen wages gets no benefit and the workers lose take-home pay.
Service charges are already treated differently from tips in two other areas of federal law. Restaurants using service charge models forfeit the FICA tip credit available under Section 45B, and they pay a higher overtime rate because distributed service charges are counted as wages. The 2025 tip deduction adds a third disparity, and the first to affect employees directly. Together, these provisions impose a cumulative federal penalty on the compensation model most likely to raise pay in the back of the house.
The IRC is advocating for the following reforms:
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Extend the tipped income deduction to service charges. Service charges distributed to non-management employees should receive the same tax treatment as qualified tips. Because restaurants that adopt service charge models forfeit the tip credit, the net cost of this change to the Treasury is substantially offset.
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Reintroduce and pass the Restaurant Service Charge Tax Fairness Act. Rep. Earl Blumenauer introduced this legislation in 2024 to exclude distributed service charges from FICA and align their overtime treatment with tips, capped as a share of the total bill and conditioned on distribution to non-management staff. Rep. Blumenauer has since retired from Congress, and the bill requires a new sponsor. Securing one is the IRC's immediate priority on this issue.
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Provide clear federal guidance. Operators evaluating a service charge model face uncertainty regarding payroll taxes, overtime calculation, and interaction with state law. Clear and consistent federal guidance would allow restaurants to make this decision based on its merits.