If you own or manage a restaurant, hotel, salon or other business with tipped employees, you already know there are plenty of moving pieces when it comes to payroll. Tips, tip pools, service charges, credit card transactions and employees who perform both tipped and nontipped work can all create additional compliance considerations.
The good news is that a little attention to these details can go a long way toward preventing bigger problems down the road. The Fair Labor Standards Act (FLSA) establishes specific rules for tipped employees, including requirements for minimum wage, overtime, tip credits, tip pooling and recordkeeping. State and local laws may impose additional requirements.
Getting these practices right isn’t just about checking a box. Clear policies and accurate records can help prevent misunderstandings with employees, reduce the risk of costly wage-and-hour disputes and make it easier to demonstrate compliance if your business is ever audited or otherwise comes under scrutiny.
Overview of the FLSA’s Tip Regulations
Tipped Employees
The FLSA’s requirements for tipped wages apply to tipped employees. Tipped employees are those engaged in occupations in which they customarily and regularly receive more than $30 a month in tips, whether they are full-time, part-time, permanent or temporary employees. A tip is a sum presented by a customer as a gift or gratuity in recognition of service performed for the customer, rather than as payment for the service. Tipped occupations commonly include waiters, bellhops, taxicab drivers, barbers, beauty operators, counter personnel who serve customers, bussers and service bartenders.
In addition to federal regulations for tipped workers, employers must be mindful of state and local laws that may offer greater protections or impose additional requirements.
Tip Credit
The FLSA allows employers to take a tip credit toward their minimum wage and overtime obligations for tipped employees. This credit allows employers to pay qualifying tipped employees a direct cash wage below the federal minimum wage while counting a limited amount of the employees’ tips toward meeting the federal minimum wage requirement. An employer that claims a tip credit must ensure that the employee receives enough tips from customers and direct (or cash) wages per workweek to equal at least the minimum wage and overtime compensation required under the FLSA.
Under the federal FLSA, an employer taking the maximum tip credit must pay a tipped employee at least $2.13 per hour in direct wages. The federal minimum wage is currently $7.25 per hour, making the maximum federal tip credit $5.12 per hour. Only tips actually received by the employee count when determining whether an employee is a tipped employee and when applying the tip credit. If an employee’s tips combined with their direct wages do not equal the applicable minimum wage for each workweek, the employer must pay the difference.
State and local laws may require a higher direct wage, a higher combined minimum wage, or may restrict or prohibit the use of a tip credit altogether. When requirements differ, employers must comply with the applicable requirements that provide the greater protection to employees.
Notice to Tipped Employees
Before employers can claim a tip credit under the FLSA, they must provide the following information to tipped employees:
- The amount of the direct (or cash) wage the employer is paying the tipped employee;
- The additional amount claimed by the employer as a tip credit;
- The tip credit claimed by the employer cannot exceed the amount of tips actually received by the tipped employee;
- All tips received by the tipped employee are to be retained by the employee except for a valid tip-pooling arrangement; and
- The tip credit will not apply to any tipped employee unless the employee has been informed of these tip-credit provisions.
Employers that fail to provide the required notice cannot claim the FLSA tip credit and must pay tipped employees the full federal minimum wage, regardless of tips received.
Tip Pooling
Tips belong to the employee who receives them. However, the FLSA permits employers to require employees to share, or “pool,” tips with other eligible employees. Pooled tips are considered the property of the employees who ultimately receive them, not of the employees who contribute the tips to the pool. Under the FLSA, the rules governing tip pools depend in part on whether the employer pays tipped employees a direct cash wage equal to the full minimum wage.
Traditional Tip Pooling
Under a traditional tip pool, an employer that takes a tip credit can require tipped employees to contribute tips only to a pool limited to employees in occupations in which they customarily and regularly receive tips. An employer that implements a traditional tip pool must notify tipped employees of any required tip-pool contribution amount. Employers cannot require employees to contribute any part of their tips that the employer is counting as a tip credit or that causes an employee to earn less than the minimum wage.
Employers may not receive tips from such a tip pool and may not allow managers and supervisors to receive tips from the pool.
Other Tip Pooling
When an employer pays its employees a direct cash wage at least equal to the full applicable minimum wage and does not take a tip credit, the employer may impose a mandatory tip-pooling arrangement that includes employees who are not employed in an occupation in which they customarily and regularly receive tips. This is sometimes known as a “nontraditional” tip pool.
For example, an employer that implements a nontraditional tip pool may require tipped employees, such as servers, to share tips with nontipped employees, such as dishwashers and cooks. Employers may not receive tips from such a tip pool and may not allow managers and supervisors to receive tips from the pool.
Service Charges
Mandatory service charges, such as an automatic gratuity added to a customer’s bill for parties of 10 or more individuals, are not considered a tip under the FLSA. They are the property of the employer. If an employer distributes any portion of a service charge to employees, that amount is treated as wages and may be used to satisfy the employer’s minimum wage and overtime pay obligations under the FLSA.
These sums are part of the employee’s total compensation and must be included in the regular rate of pay for computing overtime. If an employee receives tips in addition to the compulsory service charge, those tips may be considered in determining whether the employee is a tipped employee and in the application of the tip credit.
Dual Jobs
Some employees routinely engage in both tipped and nontipped occupations. These are known as dual-job situations. In such a situation, an employee who customarily and regularly receives at least $30 a month in tips for work in a tipped occupation is a tipped employee with respect to that occupation. However, no tip credit can be taken for hours worked in a separate, nontipped occupation.
This situation is distinguishable from that of a server who spends part of their time performing related duties such as cleaning and setting tables, toasting bread, making coffee or occasionally washing dishes or glasses. Employers should carefully distinguish between work performed as part of a tipped occupation and work performed in a separate nontipped occupation when determining whether a tip credit may be applied.
Credit Cards
Under the FLSA, when tips are charged on customers’ credit cards and the employer can show that it pays the credit card company a percentage on such sales as a fee for payment using a credit card, the employer may pay the employee the tip less that percentage. For example, where a credit card company charges an employer 3% on all sales charged to its credit service, the employer may pay the tipped employee 97% of the tips without violating the FLSA.
However, the employer cannot reduce the amount of tips paid to the employee by more than the credit card company’s transaction fee, regardless of whether it takes a tip credit. Additionally, the transaction fee may not reduce the employee’s wage below the required minimum wage, including any tip credit claimed.
Under federal law, the amount due the employee must be paid no later than the regular payday and may not be withheld while the employer is waiting for reimbursement from the credit card company. Some states have more protective laws regarding tips charged to credit cards and do not allow employers to deduct credit card fees from employees’ tips.
Recordkeeping
Employers that take a tip credit must keep records of the following:
- Each employee whose wage is determined in part by tips;
- The weekly or monthly tips received by each employee;
- The amount by which the wages of each tipped employee have been deemed to be increased by tips, as determined by the employer;
- Hours worked each workday in any nontipped occupation and the total daily or weekly straight-time payment made by the employer for those hours; and
- Hours worked each workday in any tipped occupation and the total daily or weekly straight-time earnings for those hours.
An employer that does not take a tip credit but operates a mandatory tip pool must keep records of each employee who receives tips and the weekly or monthly amount of tips each employee receives. Under the FLSA, employers must maintain payroll records for three years.
Enforcement and Penalties
The DOL’s Wage and Hour Division enforces the FLSA’s tip regulations. Violations can result in back wages and an equal amount in liquidated damages. Employers may also be subject to civil penalties for repeated or willful violations.
Generally, there is a two-year statute of limitations for the recovery of back wages and liquidated damages and a three-year statute of limitations in cases involving willful violations. FLSA remedies may be recovered through administrative procedures, litigation and criminal prosecution. Employees who sue their employers for FLSA violations may recover attorney fees, court costs and other amounts permitted by law in addition to unpaid wages and liquidated damages.
Best Practices for Complying With FLSA Tip Regulations
The FLSA requires employers that take a tip credit to comply with certain notice, recordkeeping and other requirements. Establishing effective practices to comply with these requirements not only satisfies legal obligations but also helps protect organizations during audits and disputes.
To comply with the FLSA’s tip regulations, employers can consider implementing the following employment practices.
Provide Tipped Employees With Written Notice
Before claiming any tip credit, employers should provide each tipped employee with a written notice containing the required information, including the direct wage rate, the tip credit amount and their rights to retain tips. While the notice does not need to be in writing under federal law, the DOL encourages employers to provide it in writing.
Employers can also have employees sign an acknowledgment that they have received and understand the tip-credit notice. In addition, employers should provide tipped employees with a written notice any time the direct wage or tip credit changes.
Ensure Tip Pools Are Properly Structured
Prior to implementing a tip pool, employers should determine which federal and state requirements apply to the arrangement. Employers that implement a traditional tip pool should notify tipped employees of any required tip-pool contributions and restrict participation to employees who customarily and regularly receive tips when a tip credit is being taken.
Employers with a nontraditional tip pool should ensure that all participating employees are paid at least the full applicable minimum wage and that the employer, managers and supervisors are excluded from the pool.
Treat Service Charges as Wages
If employers require customers to pay mandatory service charges, they must decide whether to distribute any portion of those charges to employees. If employers distribute service charges to employees, they should categorize and document these payments as wages rather than tips.
Employers should include any portion distributed to employees as part of their regular rate of pay for overtime calculations.
Track Tipped and Nontipped Duties for Tipped Employees
For employees who work in both tipped and nontipped occupations, employers should track the hours employees perform in each occupation and ensure they do not take a tip credit for hours worked in a separate nontipped occupation.
If employees regularly perform work in a separate, nontipped occupation, employers should ensure that they are paid at least the full applicable minimum wage for that time. Employers should also consider creating job descriptions for each tipped position, identifying the core duties of each tipped occupation and distinguishing them from duties performed in a separate nontipped occupation.
Review Credit Card Tip Deductions
If employers deduct credit card fees from employee tips, they should ensure that the deduction matches the actual fee charged by the credit card company and that applicable state law permits the deduction.
Employers should also ensure that the deducted amount does not reduce a tipped employee’s compensation below the applicable minimum wage. Tip amounts due to employees from credit card transactions should be paid by the next regular payday, even if the employer is waiting for reimbursement from the credit card company.
Maintain Accurate Tip and Time Records
Maintaining accurate tip and time records is essential for complying with the FLSA. Detailed records of hours worked, wages and tips paid, and amounts claimed as a tip credit are essential for verifying an employer’s compliance with minimum wage and overtime requirements.
Accurate records can help employers demonstrate their compliance and protect themselves against penalties and civil litigation. Employers should ensure that their recordkeeping policies and practices align with applicable federal, state and local requirements.
Conduct Internal Audits
Establishing compliant policies and practices for tipped employees is essential to preventing FLSA violations. Conducting regular audits of tip credit, tip pooling, employee notice, service charge and payroll practices helps ensure these systems and policies are operating properly.
Audits can help employers catch and correct errors before they become legal issues.
Train Managers and Supervisors
Employers can better ensure compliance with the FLSA’s tip regulations by training managers and supervisors. Employers can train managers and supervisors on tip credit requirements, tip pools, dual-job requirements and documenting an employee’s nontipped duties.
Managers and supervisors should know how to identify potential tip-credit issues and how to report them. Employers should train managers and supervisors regularly on FLSA tip-credit regulations, but at a minimum, at the time of hire and once per year thereafter. Employers can consider providing managers and supervisors with resources to enhance their understanding of the FLSA’s tip-credit regulations.
Comply With State and Local Laws
The FLSA establishes federal requirements for tipped employees, but it is only part of the compliance picture. States and localities may impose additional or different requirements involving minimum wages, tip credits, tip pooling, service charges, credit card fees, employee notices and recordkeeping.
Some jurisdictions do not permit employers to take a tip credit at all, while others establish higher minimum wage or direct-wage requirements. Therefore, employers should make sure their policies and procedures comply with the laws that apply to each location where they operate.
A Heads Up for Delmarva Businesses
If your business operates in Maryland or Delaware, there are a few additional questions worth putting on your compliance checklist. Maryland employers using a tip credit should ask: Are we providing the required Tip Credit Wage Statement to eligible restaurant employees, and does our payroll system capture the information needed to support it? Maryland specifically requires restaurant employers that use a tip credit to provide employees with a written or electronic statement showing the effective hourly tip rate of pay.
Delaware employers should ask: Are we giving employees the full amount of their credit-card tips, without deducting credit-card processing fees? Delaware law prohibits employers from withholding or diverting credit-card processing fees from employee wages or gratuities.
These are just two examples of state-specific requirements that can differ from the federal rules. For employers operating in other states—or in multiple states—the same principle applies: Don’t assume that following the federal FLSA rules means you’ve covered every requirement that applies to your business. Take a moment to review the state and local rules where your employees actually work.
The Bottom Line for Employers
For businesses with tipped employees, staying on top of wage-and-hour requirements can feel like one more thing to keep track of—but establishing good practices now can save considerable time, expense and frustration later.
A periodic review of your tip credit, tip pool, service charge, payroll and recordkeeping practices can help uncover small issues before they become larger ones. It can also help ensure that managers and employees understand how your policies work and that your records accurately reflect what is happening in practice.
FLSA requirements are only part of the picture. State and local laws may impose additional or different requirements, so employers should Be Sure their practices comply with the rules that apply to their particular location.
When it comes to employment practices, being proactive is often much easier than being reactive. Taking the time to review your policies, train your team and keep accurate records can help your business avoid unnecessary disputes, audits and legal headaches—and let you focus on what you do best: running your business.
Links and Resources
- The FLSA’s tip regulations: eCFR, 29 CFR Part 531, Subpart D
- U.S. Department of Labor: Tip Regulations Under the FLSA: dol.gov
- DOL Fact Sheet #15: Tipped Employees Under the FLSA: dol.gov
- Maryland Tip Credit Wage Statement FAQs: Maryland Department of Labor
- Delaware guidance on credit-card processing fees and employee tips: Delaware Department of Labor
This article is intended for general informational purposes and is not legal advice. Employers should consult qualified employment counsel regarding specific compliance questions and the laws applicable to their business and locations.
