Information on Merchant Accounts,
Ecommerce and Credit Card Processing

March 3rd, 2022 by J B

From Tips to Chargebacks

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If you accept tipped payments there are some potential, lesser-known, chargeback risks you should be aware of. For some types of tips, a card issuer is allowed to dispute any portion of a tip that exceeds 20% of the original sale. This is not the case with all types of tips, however, this does affect the most common tipping method for restaurants and bars. If you accept tips now or plan to accept tips you should be aware of the potential for chargebacks and understand why they might come through. Unfortunately, there is little that can be done to prevent the type of chargeback we are going to discuss, however not all is lost. While I really don’t like this set of rules, I also can’t see another way to handle it from an issuance perspective without serious changes to how cards are authorized.

Let’s set up some background:
If your business does restaurant-style tipping with a tip line and a later tip adjustment you are at additional risk of chargebacks. For businesses like restaurants, bars, hair salons, etc. there is an allowance of 20% for them to adjust a pre-authorized transaction in order to collect their tips without processing an additional sale. If you are a business in an industry that does not have these allowances you are at additional risk of chargeback if you settle a transaction for any amount over its approval.

Not all businesses accept tips via tip adjustment. Many businesses that accept tips use a method that I will refer to as tip-in-transaction. This is a method of asking for the tip at the time of sale and including that amount within the original authorization. These merchants don’t have the additional risk that comes with adjusting the settlement amount after authorization. There are some businesses that could use this method, but prefer tip adjust so they don’t have to ask for a tip or have a device that prompts the customer during checkout. That said if you are doing tip adjust today you may have the ability to switch to tip-in-transaction if it’s a fit for your business.

Let’s get into the risks for those who do adjust their tips:

The risk comes into play once the tip amount exceeds 20%. Technically your approval allows you to capture up to 20% more than your original authorization. An issuer has the ability to dispute any amount above that 20% ceiling without even notifying the cardholder. The majority of the time this never happens and so most merchants don’t even realize that it’s something that could happen. Just because the card issuer has the ability doesn’t mean they will use it. In rare instances, I have heard about a chargeback originating from extremely irregular tips on very high authorizations. Most likely this is an issuer or cardholder thinking there was some sort of mistake when entering the tip amount or maybe even attempted fraud. To me, it makes sense that issuers and cardholders would need the ability to dispute tip amounts in these cases.

Recently I have heard of and reviewed a couple of instances where the amounts were small and quite normal. For example, one chargeback I looked at was for a bar. The authorization amount was $3.00 and the customer left a $1.00 tip for a total of $4.00. The issuer was disputing $0.40 of the total transaction. When I first heard about it I was thinking there is clearly some kind of miscommunication here, why would an issuer spend time disputing a $0.40 overage on such a common thing.

What was even more perplexing is that this wasn’t the only transaction we found that was being disputed on this merchant’s account. We found 3 more that were similarly small as the first. The highest dispute was for around $1.40.

Why would an issuer spend time disputing such small amounts?

As far as we could tell this is a pre-paid gift card. Not to be confused with a pre-paid credit card. Unlike Pre-Paid credit cards, the Visa/MasterCard/Amex gift cards, like the kind you get at the grocery store and are given out around the holidays, are not linked back to an individual person.

If a business puts through a transaction that exceeds the card’s available balance by authorizing one amount but settling a higher amount then that is a real problem for those issuers. When one of those cards is processed at a restaurant they likely check the balance of the card and only approve the sale if the card’s balance exceeds the authorization amount by 20%. This would be done to prevent losses while also allowing those cards to operate in a tipping environment.

This is where it becomes difficult to find a better solution.

When tips are involved the card issuer cant know what the cardholder is going to tip. On traditional credit and debit cards, this isn’t a huge issue. The issuer can increase the balance that is owed by the cardholder. They can also charge fees for going beyond the card’s limits, or even draw a bank account negative and collect the funds and fees at a later date.

For PrePaids they have to decide between setting a tip-ceiling or setting those cards to only work at businesses that don’t accept tips.

Maybe there is a better way that the industry could handle tipped transactions on prepaid cards. One possible way is at the time of approval to have a notice printed on the receipt that the card is unable to accept over its ceiling. That way the business and the cardholder would be alerted that the card can’t accept tips beyond 20%. This would not be too different than how partial authorization work now. For some card types, the issuer can approve a transaction up to the limit or balance of the card. When the payment device prints the receipt it clearly states the card was approved for an amount lower than the total and prompts the merchant to collect another form of payment for the remaining balance due. Doing this would allow normal cards to operate as they do today while preventing chargebacks on cards that don’t allow the cardholder to exceed the ceiling.

While that is easily stated it would likely require changes to both the issuance and acquiring side of the industry. It would also take time for businesses and consumers to adapt to these changes. Businesses would catch on quite quickly, but it would likely require businesses to explain to their customers that their card has a hard tip limit which I would assume would be an annoyance at best to the business and the people receiving the tips.

People who work in tipped environments are not going to be happy about telling people they are not allowed to tip you above 20% due to the limits of their payment method.

While the amounts are small, the costs add up.

Some of you may be thinking it’s $0.40 here or there, and this doesn’t come up very often, what’s the big deal? It’s the chargeback fees. If you’re paying $15+ for each chargeback then that $0.40 overage likely costs you more than the revenue from that sale. Four chargebacks quickly because $45+ just in fees. In this particular instance, we manually waved the merchant chargeback fees but that isn’t a long-term solution.

While this isn’t a common issue, it’s one I would like to see addressed and changed. Hopefully, this is something that is in the works. In the mean, it is rare and is just something to be aware of.

You can find the actual rules from Visa here. The purpose of this article is to alert people to potential risks and is not designed to be a comprehensive guide. In order to keep this article from going on for pages, we encourage everyone to review Visa and MasterCards guidelines and understand how they may be applied to your business.

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