Lawsuits against restaurants by employees seeking wages are on the rise due to the increasing complexity of federal law governing the compensation of employees who receive tips and the extraordinary damages exposure involved in these cases. In 2011, the U.S. Department of Labor issued new regulations concerning tip-pooling arrangements and boosted enforcement of the Fair Labor Standards Act (FLSA), which requires that nonexempt employees be paid minimum wage for all hours worked and an overtime premium rate for hours in excess of 40 per week.

The restaurant industry has fought back in federal court with some success. However, this area of federal law, covering restaurant employees nationwide, remains deeply uncertain and creates significant risk for businesses because violations of federal law governing tipped employees can easily quadruple payroll liability for these workers.

The tip credit: A little math makes a big difference

Restaurants can take a credit of up to $5.12/hour against their minimum wage obligations by paying a “tipped employee” at least $2.13/hour in direct wages, provided that the employee’s total compensation, including tips, exceeds the minimum wage for each hour worked.

While this can represent an enticing 70 percent reduction in payroll liability, an employer can easily lose the tip credit by failing to comply with a variety of detailed regulatory requirements governing tip pooling arrangements and notice of the tip credit. For example, tip pools, or tip sharing arrangements, may be mandatory if they are “customary and reasonable,” meaning that the net contribution from each employee must not exceed 15 percent of the employee’s tips. However, employers cannot require “tipped employees” to pool tips with nontipped employees, or those employees who do not “customarily and regularly” receive tips. The question of who is a properly tipped or nontipped employee has been heavily litigated in federal cases, but state law may also affect tip pool liability, making this one of the more challenging problems in wage and hour compliance.

Tipped employees who successfully sue for unpaid wages can recover all unpaid minimum wages, unpaid overtime wages and an equal amount in liquidated damages. Because the employer gets no credit for the actual tips received, it is not uncommon for damages to be four times the amount the employer has already paid for hours worked (at $2.13/hour). In addition, the court is required to award a reasonable attorney’s fee to the successful plaintiff.

Common mistakes that result in a loss of the tip credit are errors related to overtime payments, notice of the employer’s intention to take the tip credit and the dual-job employee, detailed below.

The most common mistake made by employers of tipped employees is the assumption that the applicable overtime rate is $3.20/hour based on the direct wage rate ($2.13 x 1.5). In reality, overtime is calculated on the full minimum wage, and the credit taken against overtime hours cannot exceed $5.12/hour. The problem with incorrect overtime payments is that the rate is often listed on pay stubs, so employees have easy access to evidence of an illegal payroll practice.

Notice: The new requirements (at least for now)

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Notice must be provided to tipped employees that the employer intends to take a credit for the tips received by the employee. Notice can be verbal or written, but the employer should not rely only on an employee’s pay stubs to provide notice, even if they list the rates of pay. The Labor Department took the notice requirement even further in issuing the 2011 regulations, which require notice of:

1. The amount of the cash wage that is to be paid to the tipped employee by the employer;

2. The additional amount by which the wages of the tipped employee are increased on account of the tip credit claimed by the employer, which amount may not exceed the value of the tips actually received by the employee;

3. That all tips received by the tipped employee must be retained by the employee except for a valid tip pooling arrangement limited to employees who customarily and regularly receive tips;
 
4. That the tip credit shall not apply to any employee who has not been informed of these requirements.

The best practice is to deliver this information in writing at the time of hiring and to obtain a signed acknowledgement in writing from the employee.

Dual jobs: Are expeditors just a faster way to the courthouse?

“Tipped employees” are defined as employees who customarily and regularly receive more than $30 per month in tips. However, when an employee works in both tipped and nontipped capacities, or  “dual jobs,” the tip credit is available only for the hours spent performing the tipped work.

The general rule for dual jobs is that if the employee spends more than 20 percent of his or her time performing nontipped work, then the employer must pay the full minimum wage for hours spent on nontipped work, but can still pay $2.13 plus tips for hours spent performing tipped duties.

In restaurants, the most common dual job position is the expeditor or food runner. Under the new regulations, dual job employees create additional complications for restaurants that use tip-pooling arrangements because nontipped employees cannot participate in tip pools. In the absence of a clear rule for determining when a tip pool may be invalidated by nontipped worker participation, restaurants should consult with attorneys who focus on wage and hour compliance.

The 2011 regulations have escalated an already overwhelming challenge for restaurants seeking to take advantage of the federal tip credit. Complicating the issue are recent rulings by district courts that have ruled differently on the validity of the regulations, and it will likely take time for appellate courts to settle these disagreements.

Due to the statutory and regulatory ambiguity in wage and hour law, employee compensation compliance and risk management should be at the top of any restaurant’s priority list.

John Mays (john@maysandkerr.com) is a founding partner of Mays & Kerr LLC in Atlanta. His employment practice concentrates on wage and hour litigation and compliance, including individual and collective actions, salary misclassifications and unpaid overtime and minimum wage claims under the Fair Labor Standards Act.