Tips for Using the Tip Credit

It’s been three years since the U.S. Department of Labor (DOL) announced their “We Can Help” nationwide initiative, which placed a special emphasis on rooting out wage and hour violations in such industries as construction, janitorial work, hotel/motel services, food services and home health care. Unfortunately, from what I’ve seen in the news, it appears all too many employers haven’t yet received the memo. All too many continue to be tripped up by wage and hour violations.

waiter collecting tips

One big area of confusion is the “tip credit.” Under the terms of the Fair Labor Standards Act (FLSA), when you have employees who customarily receive tips, you may be allowed to take a tip credit against the normal minimum wage and overtime pay you would normally be required to pay.

The FLSA says you can take a tip credit of $5.12 per hour for those customarily tipped employees. In other words, you can pay tipped employees a minimum wage of $2.13 an hour, instead of the normal $7.25 per hour minimum. Of course, if the employee’s tips plus the $2.13 an hour you pay them doesn’t total up to at least $7.25 an hour, you also have to make up the difference. Under no account can an employee make less than $7.25 an hour, whether from wages alone or a combination of wages and tips.

(Note: Some states have more restrictive laws, and if that’s the case, you should obey the law of your state. So you’d be well-advised to check with your employment law attorney to make sure you’re complying with all the laws that apply in your jurisdiction.)

What You Need to Know Before Claiming a Tip Credit

Here are a few tips to help you avoid trouble if you have tipped employees and decide to take advantage of the tip credit:

  • Make sure your tipped employees “customarily and regularly” receive at least $30 a month in tips. If they don’t, they don’t qualify for the tip credit. You must pay them the regular minimum wage. (It’s probably OK if somebody occasionally makes less than $30 a month in tips, but that has to be a very rare situation.)
  • Explicitly tell employees you’re taking the tip credit. Don’t assume they know because “everybody does it,” or because their pay stub spells out they’re getting $2.13 an hour in direct wages.
  • Keep good records of hours worked, tips received and wages paid. You must track the amount of tips each employee receives and you must accurately track the time they work. You need this information to determine they’re making at least $7.25 an hour when their tips and wages are combined. If the tips they receive aren’t enough to bring their hourly wage up to $7.25 an hour, you need records to prove you paid them the difference. In the event of a Wage and Hour audit, good recordkeeping can mean the difference between a clean report and thousands of dollars in fines and penalties.
  • Make sure you calculate overtime properly. If a tipped employee works more than 40 hours in a work week, you must calculate their overtime based on the regular minimum wage rate (time-and-a-half at $7.25 an hour). You can then take a tip credit of $5.12 per hour against that amount. You cannot simply calculate time-and-a-half based on the $2.13 tip credit wage. Example: For each hour of overtime, a tipped worker’s overtime pay should be at least $5.76 (1.5 x $7.25 = $10.88, minus $5.12). If you simply calculated 1.5 x $2.13, you’d get $3.20, an underpayment of $2.56 per hour.
  • Don’t count “service fees” as tips. Some catering halls, dinner cruises and restaurants impose standard (compulsory) service charges for service. If you charge something like this, it generally can’t be counted toward the employee’s tips, even if you distribute all or part of the service charge to your employees. Check with your employment law advisor to be sure, but the safest course is to exclude these service charges from your tip credit calculations.
  • Allow employees to keep all their tips, with no deductions. There are two exceptions:
    1. They are part of a bona fide tip pool. (Note there are restrictions on who can participate in a tip pool. If management retains a portion of the tips, this is not “pooling,” it’s called “skimming,” and it’s illegal.)
    2. You can deduct the actual cost of transaction charges on tips for tips paid by credit card (but only the actual cost of the transaction fees, no “surcharges” that you keep for yourself) as long as the deduction doesn’t reduce the employee’s pay below minimum wage. You must also pay the employee all their tips on their regular payday regardless of when the credit card company makes the funds available to you.

Credit Where Credit Is Due

Used properly, the tip credit can help employers in the hospitality and food service industries remain profitable while ensuring fair compensation for their employees. But poor record-keeping, sloppy administration and improper deductions can cost businesses thousands of dollars in back wages, fines and penalties. Follow these tips, consult your wage and hour attorney, and use a good time tracking system to help ensure your restaurant gains the full benefits of the tip credit.

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