Managing Payroll for Tipped Employees

Paying tipped employees correctly is one of the most error-prone areas of wage and hour law. The FLSA allows employers to take a tip credit against the minimum wage obligation, but the rules are detailed and the penalties for violations are significant. Several states have eliminated or modified the tip credit, adding another layer of complexity.

Understanding the Tip Credit

Under the FLSA, a tipped employee is one who customarily and regularly receives more than $30 per month in tips. For tipped employees, the employer may:

• Pay a direct cash wage as low as $2.13 per hour (the federal tipped minimum wage)
• Take a tip credit for the difference between the direct cash wage and the full federal minimum wage
• The direct cash wage plus tips must equal at least the full minimum wage for every hour worked

If an employee's tips combined with the direct cash wage do not reach the minimum wage, the employer must make up the difference.

Requirements for Using the Tip Credit

To lawfully take a tip credit, the employer must inform each tipped employee of the following before the tip credit is applied:

• The amount of the direct cash wage the employer will pay
• The amount the employer is claiming as a tip credit
• That the tip credit cannot exceed the tips actually received
• That all tips are the property of the employee except for valid tip pooling arrangements
• That the tip credit will not apply unless the employee has been informed of these provisions

Failure to provide this notice means the employer must pay the full minimum wage and cannot claim the tip credit.

Tip Pooling Rules

Tip pooling is legal under certain conditions:

• If the employer takes a tip credit, only employees who customarily and regularly receive tips may participate in the pool (servers, bartenders, bussers, hosts)
• If the employer pays the full minimum wage and does not take a tip credit, the tip pool may include non-traditionally tipped employees (cooks, dishwashers) but may never include managers or supervisors
• Managers and supervisors may never participate in a tip pool regardless of whether a tip credit is taken
• Employers may never retain any portion of employee tips

Overtime for Tipped Employees

Calculating overtime for tipped employees requires special attention:

• The regular rate for overtime purposes is the full minimum wage, not the reduced direct cash wage
• Overtime must be paid at 1.5 times the full minimum wage
• The employer may continue to apply the tip credit during overtime hours
• The overtime rate for a tipped employee is calculated as: (full minimum wage x 1.5) minus tip credit

Dual Jobs

When a tipped employee performs both tipped and non-tipped duties:

• The tip credit can only be applied to hours spent performing tipped duties or duties directly supporting tipped work (up to a limit)
• Under DOL guidance, if more than 20 percent of a tipped employee's time is spent on non-tip-producing supporting duties, or any time is spent on non-tip-producing duties unrelated to tipped work, the tip credit cannot be applied to those hours
• Track time spent on different duties carefully

State Law Variations

Several states do not allow a tip credit or set a higher tipped minimum wage:

• California, Washington, Oregon, Nevada, Montana, Minnesota, and Alaska require employers to pay the full state minimum wage before tips
• Many other states set tipped minimum wages higher than the federal $2.13
• Some states have additional tip pooling or tip notice requirements

Always check the applicable state law and apply the standard most favorable to the employee.