Understanding When Tips Are Subject to Sales Tax in Minnesota & South Dakota
Businesses often assume that if a tip isn’t subject to federal income tax withholding rules, it must also be exempt from sales tax. But sales tax is a state question, and states determine for themselves whether a gratuity is taxable. Minnesota and South Dakota provide straightforward but different guidance on when a tip becomes a taxable charge.
You’re Not Alone if This Feels Confusing
Tips, gratuities, service fees—customers use these terms interchangeably, and sometimes businesses do too. States, however, see a meaningful difference between a customer deciding to leave a tip and a business adding a mandatory percentage to the bill. Many businesses struggle with this distinction, and it’s normal to feel unsure about how each charge should be treated. State rules provide structure, but every business situation is unique, so be sure to discuss your circumstances with a tax professional.
Unfortunately, there is no “One Size Fits All” answer.
States vary in how they define things and how they apply taxes. Below are excerpts from each state’s publication that are relevant to this topic. (source documents are linked at the end of the article). If you want to learn more about this topic, the Brady Martz team is ready to assist.
Minnesota:
Voluntary Tips “Tips that a customer voluntarily leaves or adds to a credit card receipt are not taxable.”
Tips Added by Seller “Tips or service charges a seller adds to the bill are taxable, even if the tip amount is given to employees.”
South Dakota:
“Some businesses collect the tips for their employees.
If the tip is added to the bill and is a mandatory charge for services,
- it is subject to the sales tax. For example, if a restaurant serves a dinner to an organization and adds a 15% tip when the organization is billed, the entire charge, including the tip, is subject to the sales tax.
If the tips collected by the business are voluntary tips paid by the customer,
- the tip is not subject to sales tax”
What This Means for Your Business
Reviewing how your point-of-sale systems handle these charges can help ensure compliance. When in doubt, check the rules or consult a professional familiar with your operations here at Brady Martz.
References:
Minnesota Department of Revenue. (2023, April 11). Eating establishments guide. Retrieved from https://www.revenue.state.mn.us/book/export/html/12466
South Dakota Department of Revenue. (2023, July). Bars and restaurants. Retrieved from https://dor.sd.gov/media/x5wn31vv/restaurants-and-bars.pdf
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