Many of your customers probably include a tip as part of the total when they use their credit card at your restaurant. But did you know that tips over a certain percentage can have impacts on your bottom line?
There are two possible effects of high tips left on credit cards: more expensive interchange costs through downgrades, and chargebacks initiated by the card issuer.
This is the more common and more expensive of the two scenarios. Interchange fees are the largest component of credit card processing costs, so the lower those costs are, the better. Every time you accept a credit card, it goes to an “interchange category” with an associated cost. A “downgrade” means that a transaction is routed through a more expensive interchange category, resulting in a higher cost for you.
If the tip is under 20% of the total bill, the transaction will usually go to an interchange category based on the type of card (debit, credit), card brand, (Visa, MasterCard, etc.) and input method (swiped, online entered, etc.) Through your processor, you pay the interchange associated with the transaction's category.
However, if a tip left on a credit card is over 20% of the total bill, the transaction may be routed to a more expensive “catch-all” interchange category. If lots of your transactions are going to a more expensive category, it can eat away at your profits.
How to Avoid Interchange Downgrades
A number of factors affect what interchange category your transactions are routed to, but this is one of the few situations where it's not your fault if a transaction is routed to a more expensive category because of a generous gratuity. Unfortunately, that also means there isn’t much that you can do to minimize the risk of a downgrade.
What you can do is focus on ensuring that you’re taking every possible step to ensure that other transactions aren’t downgrading, too. Your processor can work with you to help determine what steps you need to take. For example, if your restaurant takes online orders, you may be able to take advantage of fraud prevention tools like Verified by Visa in order to secure lower rates at the interchange level.
Some companies, such as Toast, pay their customers' interchange on their behalf, so downgrades are never something they have to worry about. Other point of sale and credit card processing companies have different rules around this.
Tip tolerance and chargebacks
Tip tolerance is handled slightly differently by various credit card companies, but roughly what happens is this: when you swipe a credit card at your restaurant, the amount authorized includes a 20% “tip tolerance.” Your customer’s card will be pre-approved if they have enough available funds for 120% of the total bill. The card companies do this to account for the possibility of a customer leaving a 20% gratuity for their server.
While 20% is fairly standard for tips in the United States, some customers do tip more. If they do, it may set off a warning (also called “tripping a flag”) to the issuer, alerting them to possible fraud. The issuer can choose to initiate a chargeback, requiring information from you to determine if the transaction is valid. (Note that the issuer does not need the customer’s permission to initiate a chargeback, and your customer may not even be aware that the transaction is in dispute.)
The good news is that issuer chargebacks for small checks or for tips close to 20% isn’t very common. (Tips that are much larger than 20% are more likely to see a chargeback.) It does happen, though, and can be frustrating and confusing to restaurant owners when it does.
New technologies are also throwing wrenches into the typical understood rules. Different EMV cards (chip and pin vs. chip and signature) and different card brands (VISA, MasterCard, Discover. etc.) have different rules about restaurant tipping. In particular, MasterCard has announced that there is no tip tolerance for EMV chip cards, online transactions, and contactless payments like Samsung Pay. If you find yourself doing a pre-authorization for an estimated amount, MasterCard requires a second authorization for the final total. Skipping the second authorization could prompt an issuer-initiated chargeback and more headaches for you.
That said, we generally suggest that restaurants adopt a practice of entering total + tip at once, because it's true that the traditional way of tipping won't work with some EMV cards. Since which cards will and won't work would be a bit of a headache to figure out at the server/restaurant owner level, we just suggest restaurants adopt a method that will work for all EMV cards, which would be entering the total and the tip at the same time. For more info on what EMV chip cards mean for tipping, click here.
Handling a chargeback for a large tip
Chargebacks for large tips are handled the same as other chargebacks. If you get one, respond to requests for information from your bank or processor promptly and as completely as possible. Any documentation you can provide to show that the transaction is valid (like a signed credit card receipt) can help the chargeback process. Don’t ignore requests for information, as that can quickly cause you to lose a chargeback even if the transaction is completely valid.
Toast Payroll & Team Management
With Toast Payroll & Team Management, worry less about credit card tips and chargebacks. As the leading technology platform powering thousands of successful restaurants across the US, Toast's restaurant-specific payroll & team management platform helps our community save time each pay period, onboard new employees faster, protect their businesses, and do more for their teams.