Service Charge 101: How this model works for us

The hospitality industry is evolving in Washington and Oregon, as it is across the country. With recent legislation at the federal, state and city level affecting minimum wage, tip-pooling practices, sick leave and predictive scheduling, it is hard to keep up with all the new rules and terms. When the Seattle City Council voted for a $15 minimum wage in 2015, we looked at a variety of ways to address the changing labor market. When the 9th Circuit Court eliminated Tip Pooling in February 2016 and the Seattle City Council enacted new scheduling legislation in 2016, our team knew we would need to change our model in order to compete in a tight labor market. We looked at different models, weighing the pros and cons, and landed on a service charge to ensure that our team is well compensated and continue to attract top talent while ensuring that our guests continue to receive an outstanding experience and our company is well positioned for the future.

A growing number of restaurateurs are experimenting with new ways of doing business, and there’s no one right answer. In April 2016, our Seattle-based restaurants moved to a 20% service charge model, El Gaucho Portland will begin in July 2017, and Miller’s Guild in August. Eventually, it will roll out company-wide. With all of the changes in the industry, there have been many explanations and terms used that can be confusing. Here are some definitions to help break it down:

Glossary of Terms:

Service Charge: A service charge is a set percentage added to every guest check. The total amount of the service charge is the property of the restaurant which helps pay for labor and benefits for all employees. The service team is paid an hourly wage and a commission (see graphic).

Gratuity: A gratuity, or tip, is money paid for service -in addition to the check. Tips are usually shared between the server, bar and support staff, including bussers and hostesses.

Hospitality Included: Some restaurants choose to raise menu prices and eliminate tips and service charge to offset the increases in labor costs.

Tip-Pooling: A valid tip pooling practice involves the collection of all tips to be put into one large “pool.” Tips are then redistributed among a larger group of employees. In theory, tip pooling ensures that all staff members are fairly compensated for their work, especially when there are multiple services being rendered and single points of payment. Only usual and customarily tipped employees can be part of the pool. Employees can’t be required to share their tips with employees who don’t usually receive their own tips, like dishwashers or cooks.

Tip Credit: Under federal law and in 43 states, employers may pay tipped employees less than the minimum wage, as long as employees receive enough in tips to make up the difference. This is called a “tip credit.” The credit itself is the amount the employer doesn’t have to pay, so the applicable minimum wage (federal or state) less the tip credit is the least the employer can pay per hour. If an employee does not earn enough in tips during a given shift to earn the applicable minimum wage, the employer has to pay the difference. Since 1992, Washington and Oregon have not allowed tip credit.

Frequently Asked Questions:

In the traditional tipping model, do servers keep all their tips?
No, there has always been a practice of tip pooling where the tip amount is distributed between the server, bar staff and support staff including bussers and hostesses.

How are employees compensated in a service charge model?
Each member of the service team is paid an hourly wage and a commission. Some restaurants, including El Gaucho, include the ability for guests to leave an additional gratuity which goes directly to the server.

Are service charges considered wages, tips, or a benefit for employees?
A service charge is the property of the restaurant and the restaurant then pays hourly rates, commissions and revenue share to employees which are subject to wage-related taxes, and are reported by the employer to the IRS.

What are the benefits of a service charge model?
Employees: Our team is made up of professionals who have made hospitality their career -they have families, are homeowners, and active members of their community. The service charge model, combined with the ability for guests to leave additional gratuity for excellent service, ensures a sustainable model for our team to continue to receive excellent compensation and benefits. For example, our servers are paid a 13% commission plus state minimum wage which results in $40-60 hourly pay plus benefits.
The Company: El Gaucho has been successfully using a service charge model for Private Dining business for over 20 years, therefore we already have extensive experience with this model. The advantage is that we pay the state minimum wage and then a commission, rather than the city of Seattle’s minimum wage. The delta between the two saves money for our company, while ensuring that our employees continue to do well.
The Government: Because taxes are paid on the service charge, state and local government benefits from increased tax revenue. $15 million gross sales creates $3 million in service charges and $300K goes to Washington State sales tax and $60K goes to B&O taxes.

Why don’t the percentages in the graphic add up to 100%?
The restaurant now pays the credit card fees (averages 3-4%), whereas in the old model the servers paid those fees; additional .5% B&O tax and the loss of the FICA tip credit, we actually pay slightly more than the 1% not represented in the graphic.

Other Resources:
Restaurant Hospitality Magazine story about compensation models
• Chad’s thoughts on Seattle scheduling legislation
Chad’s blog on the El Gaucho service charge announcement

diagram for service charge policy

diagram for service charge policy

  1. Marilynne Frizzell

    This was very good information. What I didn’t like was paying taxes on your service charge. Why should the customer be burdened with more taxes, especially since we pay a high sales tax of 10% already? Yes, governments get more revenue at the expense of the consumer. In my view it’s not win win as you make it sound. It’s win win for everyone but the customer. In my case I won’t go out to restaurants as frequently as I do now. It’s win win for me because I’ll save money and eat healthier food at home.

  2. Joan E. O'Brien

    It seems strange to me that you charge tax on the 20% service charge/gratuity. Customers aren’t taxed on tips they’ve left. I think ultimately, this new practice will result in el gaucho recouping the additional wages required but your best servers making LESS money as that 20% gratuity goes in to a pool. this just seems like a bad idea – and being in a very high sales tax state to begin with, that extra tax on the charge irritates me – I’d rather leave a 20-30% tip.

  3. Ronald Spaulding

    I appreciate your explanation of the service charge and tipping models. In fact I have been tipping20% anyway so the cost of my dining has not changed. I was put off by the service charge when I first encountered it because I felt like it took away my ability to decide on the amount of a tip. I have never encountered bad service at ElGaucho or Aqua but it could happen and may be I would want protest by tipping less.

    I wonder now when I get exceptional service how much to give the waiter. $5, $10, 2% or 5% of the pre-service charge bill. Any thoughts?

  4. Ron wagner

    My understanding was that Washington started a $15.00 minimum wage. As a result fewer people have been employed or work fewer hours. Appears to me this is not as good as the old system.

    In addition Oregon does not have sales tax.

  5. Lisa Van Kampen

    If the service charge were only applied to food, I wouldn’t mind it so much. If we order the same food as the next table, but enjoy a nicer bottle of wine, we pay more for the same meal. It is very bothersome.

  6. Jon Gaddis

    I too appreciate the explanation, I just encountered this in Portland and was confused. I did not realize this was in place, guess I need to visit El Gaucho more often!

  7. Julie Ballantine

    Not long ago I lived in Florida and many waitresses worked part time with $3 / hour. Waitresses, service workers, elder care attendants, etc. may be payed a lot less than others there. This was partly due to tipping is considered half of their hourly wage in some jobs there. The cost of living is Not cheaper there in south west FL than here. (Housing , daycare, food, basic necessities, clothing, dental and medical care and insurance, cable / internet, etc ) So , basically the customers are paying their hourly salaries. No wonder why the waitress at I-Hop was missing front teeth and looking rough. Perhaps a prison release position.
    I would think $15 / hour min. wage is a living wage and keeps those employees off welfare (taxes).
    I would rather see people make a living stable wage than rely on tips. Seems stressfully unpredictable and discouraging .
    I don’t consider a service charge a “tip” but just added fees rather for whatever reason or excuse.
    I guess sudden drastic changes can cause businesses to find ways to drastically adapt also. But government has to step in when cost of living goes up as well as greed, and the wage gaps also increases.
    I also appreciate the detailed information and explanation provided here.

  8. Christine

    Wow, so much complaining about a tax on service charge by people who are lucky enough to dine at such a high-end restaurant! It’s just embarrassing. If I can afford dinner for two with ALL the trimmings, I can certainly afford that little extra.

  9. Jon Roelofs

    Thank you for the graphics and explanations. Certainly helps to understand what you need to do to provide such great service and the costs associated with it. A lot of thought and work went into designing such a system. Thank you.

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