
Commentary by TSG Senior Associate, Jeff Fortney
Tipping Background
Tipping has been a common practice in restaurants for multiple decades. As card use increased, technology simplified the tipping process. This simplification has resulted in higher tip amounts as consumers are no longer restricted to cash on hand. Instead, they tend to choose an amount by percentage.
Although restaurants remain the predominant industry that supports tips, recently, the option to add a tip has gained traction in other merchant types, including retail.
Tips are a large part of the income servers and other restaurant staff earn. In the political arena, removing tax on tips has even become a talking point for candidates. Tipping is that important.
Today’s Payments Process
The current processing rules in the U.S. allow restaurants to adjust the transaction to include the tip after authorization. Alternatively, several point-of-sale solutions offer pay-at-the-table options, which allow the tip to be added to the transaction before authorization. In this scenario, the tip amount becomes part of the overall transaction total.
Typically, at the end of the workday, all transactions are submitted for settlement and payment to the merchant.
The total amount of each transaction is submitted to the appropriate card issuer to allow for settlement and post against the chosen card. Acquirers then calculate interchange. This is currently an automated process, with all requirements for each category considered.
Enter the Interchange Fee Prohibition Act
In May, Illinois passed the Interchange Fee Prohibition Act (IFPA), which prohibits issuers, acquirers, processors, and payment card networks from receiving any interchange fee or charging a merchant any interchange fee on the tax amount or gratuity in an electronic payment transaction. As defined in the Act, “Interchange fee” means a fee established, charged, or received by a payment card network to compensate the issuer for its involvement in an electronic payment transaction.
Under the IFPA, acquirers will have to modify the current interchange calculation process so tips and tax are excluded before the calculation. This will also require that the amounts for tips and tax be submitted with each transaction but still included in the total transaction to allow for settlement to the card issuer.
The result will likely be a separate system for Illinois. Potentially, the cost of the changes may result in unique interchange for Illinois that recoups the cost of this one-off system.
Impact
Contrary to the Act’s stated goal, it will not likely reduce the cost to the merchant or the consumer. Several considerations could likely occur:
- Tip options at the point of sale may be suppressed for Illinois restaurants. As a result, the only tipping option may be cash. This may result in a reduced tip, as it will depend on the consumer’s available cash. Subsequently, this will likely reduce the waitstaff’s revenue.
- The merchant may require that the tip amount be provided prior to processing the transaction. The tip will become a part of the overall transaction and will not be reported separately. This will complicate the calculation of collected tips at the end of the day (and may be considered ‘working around the rules’).
- The merchant may increase prices to reflect the amount of a normal tip. This fixed amount may be less than the normal tips received. The goal may be to provide the same revenue to the waitstaff, but it will make the process cumbersome. Raising prices would likely require reprinting menus as well.
- Retail tipping will likely be disabled in Illinois. The impact on the retail merchant may not be significant, but less revenue will be collected.
Current Status
In August, the Illinois Bankers Association and the American Bankers Association filed suit in Federal Court to block the IFPA. Several restaurant associations have joined with the initial plaintiffs. The Office of the Comptroller of the Currency (OCC) filed an amicus brief against the IFPA.
The American Retail Association has filed an amicus brief in support of the IFPA. Additionally, the Illinois Attorney General has filed a brief opposing the banker filing and in support of the bill. The Attorney General’s office concedes that the bill does not outline the IFPA’s enforcement. The penalties are, but the mechanics of enforcement are not listed.
Recently, Senator Dick Durbin of Illinois spoke in favor of the law, stating that it is in line with the rules surrounding debit card acceptance.
The first hearing was in August. The Judge has requested additional information from all parties. IFPA becomes effective in June 2025.
Questions about this or other payments industry regulation? TSG supports the payments industry with intelligence, analytics, compliance support, and general strategic consulting on market shifts. Contact us to learn more.