The simple act of tipping has become a serious legal concern for the restaurant and other hospitality industries. As the Department of Labor’s enforcement efforts increase and private wage and hour lawsuits explode, these industries are prime targets for tipped employee violations. To further complicate matters, effective January 2014, the IRS implemented new guidelines for tips and service charges. Foodservice employers must ensure compliance with applicable laws. This article will attempt to untangle the web of laws and regulations and provide some practical “tips” for employers.

The ground rules

All nonexempt employees must be paid the minimum wage under federal (currently $7.25) and state law (varies). A recent White House report promoting a substantial jump in the federal minimum wage has prompted renewed discussion about how tipped employees are compensated. Under the federal Fair Labor Standards Act, tipped employees are those who regularly receive more than $30 per month in tips. The Department of Labor’s position is that tips are the sole property of the tipped employee and that any arrangement between the employer and the tipped employee, whereby any part of the tip received becomes the property of the employer, is unlawful.

The tip credit provisions of the FLSA permit an employer to pay tipped employees no less than $2.13 per hour in cash wages and take a “tip credit” equal to the difference between the cash wages paid and the federal minimum wage. The tip credit may not exceed the amount of tips actually received and, under the current minimum wage, may not exceed $5.12/hour (the difference between the federal minimum wage of $7.25 and the minimum tipped wage of $2.13). For example, under federal law, an employer can pay a tipped employee $2.13/hr and take a “tip credit” of $5.12/hour, provided the tipped employee makes sufficient tips to cover the tip credit. If the employee does not earn sufficient tips for the tip credit, the employer must make up the difference to ensure the employee receives minimum wage for all hours worked. Employers must keep clear records to demonstrate proper application of the tip credit.

If an employer elects to use the tip credit provision, the employer must:

  • provide specific information to each tipped employee about the tip credit amount and other required information
  • allow the tipped employee to retain all tips, except to the extent that there is a valid tip pooling arrangement
  • be able to show that the employee receives at least the minimum wage by combination of direct wages and the tip credit claimed

When an employee performs both tipped and nontipped duties, such as waiting tables one day and washing dishes the next, the tip credit is available only for the hours worked in the tipped position. A tip credit may be taken, however, for time spent in duties incidental and related to the tipped position, such as preparatory and closing activities, if the tipped employees do not spend more than 20 percent of their time on such incidental duties.

The use of the tip credit also can be complicated by state laws. Some states forbid the use of tip credits, while others impose significant record-keeping and/or notice requirements on their use.

Some employers might be tempted to not require employees to report tips under $30/month or report tips beyond what brings them up to the amount of the tip credit taken. Both of these practices are flawed and could create tax liability.

To complicate matters further, the definition of a tipped employee for purposes of IRS reporting differs from the FLSA. The IRS defines a tipped employee as one who earns $20 or more per month in tips. Under IRS rules, employees must report to their employer the total amount of tips they receive and provide the employer with written reports by the 10th of the following month. Employees who receive tips of less than $20 in a calendar month are not required to report their tips to their employer, but must report these amounts as income on their tax returns and pay necessary taxes.

Therefore, even if an employee is not deemed a tipped employee under the FLSA, per the IRS the individual may still be considered a tipped employee for purposes of reporting the income generated by tips. The best practice is to simply require employees to report all tips.