Does Illinois sales tax apply to a mandatory service charge or tip added to a restaurant bill?

Plain-English summary

This letter answers a consumer complaint about a restaurant that added a mandatory "service charge" (labeled "tip" on the receipt) for parties of three or more, and then charged sales tax on that amount. The Illinois Department of Revenue explained when mandatory service charges are, and are not, subject to Illinois sales tax (the Retailers' Occupation Tax and its companion Use Tax).

The general rule: Illinois sales tax is measured by a retailer's gross receipts, and the "costs of doing business" are part of those taxable gross receipts even when they're separately itemized on the customer's bill. Normally that would sweep in a service charge. But the Department's regulations carve out an exception for mandatory service charges that are separately stated on the bill and actually turned over to the employees who directly work the food or beverage function (preparing, serving, hosting, or cleaning up) — as tips or as a substitute for tips. To the extent the charge is truly passed through to those employees as a gratuity, it is not taxable.

The exception only holds up if the retailer's own books and records prove it. If payroll records show the service-charge proceeds are actually paid out as wages, or used to cover labor costs, employee benefits, or other costs of doing business, then that money is taxable gross receipts after all — regardless of what the receipt calls it. All sales are presumed taxable, and the retailer carries the burden of proving otherwise.

The letter doesn't resolve the specific complaint (it can't — it's a GIL, not an investigation), but it tells the consumer, and any restaurant reading it, exactly what evidence would decide whether that "tip" on the bill should have been taxed.

What this means for you

Restaurants, caterers, and hospitality businesses

If you impose a mandatory service charge or automatic gratuity (commonly for large parties or banquet/catering events), it is exempt from Illinois sales tax only if: (1) it's separately stated on the bill, and (2) it is actually paid over, in full, to the employees who directly worked that food or beverage function — as a tip or tip substitute. If any portion is retained by the business, folded into regular wages, or used to offset labor costs or other business expenses, that portion becomes taxable gross receipts, even though it's labeled a "tip" or "service charge" on the receipt. Purely voluntary gratuities (left to the customer's discretion) are never part of taxable gross receipts in the first place.

Accountants and tax professionals

Because all sales are presumed taxable, your client bears the burden of proof. Payroll records need to clearly show that service-charge proceeds flow through to service employees as gratuities, not as disguised wages — the Department points specifically to payroll records as the evidence that decides this. Under 35 ILCS 120/7 and 86 Ill. Adm. Code 130.801(b)-(c), retailers must maintain complete books and records documenting deductions and gross receipts to support any tax-exempt treatment of a service charge; if the paper trail instead shows the charge funding wages or employee benefits, expect the Department to treat it as a taxable cost of doing business under 86 Ill. Adm. Code 130.120(r).

Common questions

Q: Is a mandatory 20% gratuity for large parties taxable in Illinois?
A: Not if it is separately stated on the bill and fully passed on to the service staff who worked that event as a tip or tip substitute. If the restaurant keeps any of it, or pays it as wages instead, that part is taxable.

Q: What's the difference between this and a voluntary tip?
A: Voluntary gratuities that the customer chooses to leave are never included in taxable gross receipts at all. Mandatory service charges get the same tax-free result, but only when the retailer can document that the proceeds actually went to employees as gratuities.

Q: What records does a restaurant need to keep to support treating a service charge as exempt?
A: Complete books and records showing gross receipts and any claimed deductions, including payroll records demonstrating the service-charge proceeds were paid to employees as gratuities rather than as wages or to cover other business costs. See 35 ILCS 120/7 and 86 Ill. Adm. Code 130.801(b)-(c), (g)(2).

Q: Can this GIL be relied on as binding guidance for my own restaurant?
A: No. It is a General Information Letter, not a Private Letter Ruling. It merely points to the relevant regulations and is not a statement of Department policy or binding on the Department. See 2 Ill. Adm. Code 1200.120.

Q: If the service charge is used to pay for kitchen equipment or employee benefits instead of directly as tips, is it taxable?
A: Yes. To the extent the charge funds or pays wages, labor costs, employee benefits, or other costs of doing business, it is taxable gross receipts under 86 Ill. Adm. Code 130.120(r) and 130.2145(d).

Citations and references

Statutes:

• 35 ILCS 120/2 (Retailers' Occupation Tax Act — imposition of tax)
• 35 ILCS 105/3 (Use Tax Act — imposition of tax)
• 35 ILCS 120/1 (selling price / amount of sale)
• 35 ILCS 120/7 (retailer recordkeeping)

Regulations:

• 86 Ill. Adm. Code 130.101 (measure of Retailers' Occupation Tax)
• 86 Ill. Adm. Code 130.120(r) (taxable costs of doing business)
• 86 Ill. Adm. Code 130.140 (costs of doing business as part of gross receipts)
• 86 Ill. Adm. Code 130.2145(d) (mandatory service charges/gratuities)
• 86 Ill. Adm. Code 130.801(b)-(c), (g)(2) (recordkeeping; presumption of taxability)
• 2 Ill. Adm. Code 1200.120 (General Information Letters)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2024.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2024/ST24-0019-GIL.pdf

Original ruling text

ST 24-0019-GIL 04/22/2024 MANDATORY SERVICE CHARGE
Mandatory gratuity charges which are separately stated and paid directly by a
retailer to its service employees are not subject to tax provided that the proceeds
of the service charge are in fact turned over as tips or as a substitute for tips to
the employees who participate directly in preparing, serving, hosting, or cleaning
up the food or beverage function with respect to which the service charge is
imposed. See 86 Ill. Admin. Code 130.120(r); 86 Ill. Admin. Code 130.2145(d).
(This is a GIL.)
April 22, 2024
NAME
ADDRESS
Dear NAME:
This letter is in response to the complaint that you filed on January 1, 2024, with
the Illinois Office of the Attorney General regarding collection of sales tax on certain
items. The Office of the Attorney General forwarded your complaint to the Illinois
Department of Revenue. The Department issues two types of letter rulings. Private
Letter Rulings ("PLRs") are issued by the Department in response to specific taxpayer
inquiries concerning the application of a tax statute or rule to a particular fact situation.
A PLR is binding on the Department, but only as to the taxpayer who is the subject of
the request for ruling and only to the extent the facts recited in the PLR are correct and
complete. Persons seeking PLRs must comply with the procedures for PLRs found in
the Department's regulations at 2 Ill. Adm. Code 1200.110. The purpose of a General
Information Letter ("GIL") is to direct taxpayers to Department regulations or other
sources of information regarding the topic about which they have inquired. A GIL is not
a statement of Department policy and is not binding on the Department. See 2 Ill. Adm.
Code 1200.120. You may access our website at www.tax.illinois.gov to review
regulations, letter rulings and other types of information relevant to your inquiry.
The nature of your inquiry and the information you have provided require that we
respond with a GIL. In your letter you have stated and made inquiry as follows:
NAME OF SELLER/PROVIDER OF SERVICE
COMPANY
ADDRESS1
COMPLAINT DESCRIPTION
The restaurant is charging a tip charge on top of my total bill, and taxing
on the tip on the total bill. They claim its a service charge for parties of 3 or
more but on the receipt it says tip and the tip was also taxed.
REQUESTED RELIEF
Some form of regulation as to not be taxed on mandatory tips.
NOTIFY BUSINESS

NAME
April 22, 2024
Page 2
Please do not send this complaint to the business.
DEPARTMENT’S RESPONSE:
The Retailers' Occupation Tax Act imposes a tax upon persons engaged in this
State in the business of selling tangible personal property at retail to purchasers for use
or consumption. 35 ILCS 120/2. The Use Tax which complements the Retailers'
Occupation Tax is imposed on the privilege of using, in this State, any kind of tangible
personal property that is purchased anywhere at retail from a retailer. 35 ILCS 105/3.
These taxes comprise what is commonly known as "sales tax" in Illinois. The
information provided in this GIL is intended to provide you with the tax provisions
relevant to your inquiry regarding the taxation of mandatory service charges.
The Retailers' Occupation Tax is measured by the gross receipts from sales of
tangible personal property made in the course of business. See 86 Ill. Adm. Code
130.101. "Selling price" or the "amount of sale" means the consideration for a sale
valued in money whether received in money...and shall be determined without any
deduction on account of the cost of the property sold, the cost of materials used, labor
or service cost or any other expense whatsoever...." 35 ILCS 120/1. The costs of doing
business are an element of the retailer's gross receipts subject to tax, even if separately
stated on the customer's bill. See 86 Ill. Adm. Code 130.140.
The tax does not apply to receipts from mandatory service charges that are
separately stated on customers' bills to the extent that the proceeds of the service
charge are in fact turned over to the employees as tips or as a substitute for tips to the
employees who participate directly in preparing, serving, hosting, or cleaning up the
food or beverage function with respect to which the service charge is imposed. See 86
Ill. Adm. Code 130.2145(d). However, to the extent that the service charges are used to
fund or pay wages, labor costs, employee benefits, or employer costs of doing
business, such charges are taxable gross receipts. See 86 Ill. Adm. Code 130.120(r);
86 Ill. Adm. Code 130.2145(d). Voluntary gratuities are not included in taxable gross
receipts.
If the proceeds from mandatory service charges are not taxed, the retailer must
show through its books and records that the gratuities are paid to the employees as a
gratuity and not in the form of higher wages or used for other purposes. For example, if
the retailer's payroll records show the proceeds from mandatory service charges are
being paid to employees as wages rather than gratuities, then the mandatory gratuities
will be subject to retailers' occupation tax.
All sales of tangible personal property are presumed subject to tax, and the
burden of proving that a transaction is not taxable is upon the person who would be
required to remit the tax to the Department if such transaction is taxable. See 86 Ill.
Adm. Code 130.801(g)(2). A retailer's obligation to maintain books and records to
support any claims of exemption from sales tax is governed by Section 7 of the

NAME
April 22, 2024
Page 3
Retailers' Occupation Tax Act, 35 ILCS 120/7. Retailers must maintain complete books
and records which document, and clearly explain all the information regarding
deductions as well as gross receipts required for tax returns. See 86 Ill. Adm. Code
130.801(b)-(c).
If the mandatory service charge described in your letter was treated by the
retailer as a cost of doing business rather than as gratuities turned over as gratuities to
its employees, the mandatory service charge would have been subject to retailers'
occupation tax.
I hope this information is helpful. If you require additional information, please
visit our website at www.tax.illinois.gov or contact the Department's Taxpayer
Information Division at (217) 782-3336.
Very truly yours,
Tom Grudichak
Associate Counsel
TG:sc