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Serving Up Compliance: How to Navigate Tip Credit and Tip Pooling Regulations
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Serving Up Compliance – How to Navigate Tip Credit and Tip Pooling Regulations

One Minute Takeaway

  • A tip credit is a federal law that allows employers to pay employees who regularly receive tips, such as servers and bartenders, less than the federal minimum wage.
  • Some states have their own minimum wage laws for tipped employees, which may be higher than the federal minimum wage.
  • If an employee’s tips plus their hourly wage do not add up to at least the regular minimum wage, it’s on the restaurant owner or manager to make up the difference.
  • If an employer requires tipped employees to share their tips with nontipped workers or managers, then the employer cannot take a tip credit.

As a restaurant owner or manager, you’ve got a lot on your plate (pun fully intended). Between managing your staff, keeping your customers happy, and making sure your food is top-notch, the last thing you want to worry about is compliance with tip credit and tip pooling regulations. This article covers what a tip credit is, how to calculate it, and how to comply with state and federal minimum wage laws.

Minimum Wage for Restaurant Employees

The Department of Labor’s (DOL) Fair Labor Standards Act (FLSA) is the federal law that sets minimum wage, overtime pay, recordkeeping, and youth employment standards for employers. As a restaurant employer, it’s important to understand the FLSA and comply with its regulations to avoid potential legal issues. According to the federal government, a tipped worker is anyone who regularly receives at least $30 per month in tips (the key word being “regularly”); also keep in mind, some states have different thresholds.

Currently, the federal minimum wage for tipped employees is $2.13 per hour (also known as the minimum direct wage), while regular federal minimum wage is $7.25 per hour. If an employee’s tips plus the minimum direct wage don’t add up to at least the regular minimum wage, its on you to make up the difference. We’ll cover how that works in a minute.

To further complicate matters, some states have their own minimum wage laws for tipped employees, which may be higher than the federal minimum wage so you need to keep an eye on that rate in the states you operate in.

While we’re on the topic of FLSA, in addition to complying with minimum wage laws, it’s important to ensure that all of your employees are classified correctly. Misclassifying employees as independent contractors or exempt from overtime pay can result in costly legal issues. Under the FLSA, non-exempt employees must be paid at least one and a half times their regular rate of pay for any hours worked over 40 in a workweek. This includes employees who receive tip credit.

What Is a Tip Credit?

A tip credit is a federal law that allows employers to pay employees who regularly receive tips, such as servers and bartenders, less than the federal minimum wage. Federal tip credit is $5.12 ($7.25-$2.13). Just like minimum wage, however, some states also have their own maximum tip credit.

Tipped employees must be allowed to keep all of their tips; if an employer requires tipped employees to share their tips with nontipped workers or managers, then the employer cannot take a tip credit. To make time tracking even more complicated, if an employee spends more than 20% of their time performing nontipped duties (such as rolling silverware or manning a kitchen station), then the employer cannot take a tip credit for those hours worked; instead, the employee must be paid at least the full federal minimum wage for all hours worked.

How to Calculate Tip Credit

Calculating tip credit can be a bit tricky, but it’s important to get it right to avoid potential legal headaches. Here’s an example of how to calculate a tip credit based on federal minimum wage:

Let’s say you have a server named Ramon who works 30 hours per week and takes home $200 in tips. To calculate Ramon’s pay per hour for that pay period, you would multiply $2.13 by the number of hours he worked and then add his tips to get the total ($2.13 x 30 = $63.90, $200 + $63.90 = $263.90). To get Ramon’s hourly wage, divide his earnings by the number of hours he worked ($263.90 ÷ 30 = $8.79). $8.79 is higher than minimum wage, so that is the full amount of wages Ramon earns for that pay period.

The following week, Ramon is scheduled for 30 hours again but this time he only earns $100 in tips. Using the same formulas ($2.13 x 30 = $63.90, $100 + $63.90 = $163.90) and ($163.90 ÷ 30 = $5.46), Ramon’s hourly wage that week is $5.46, which is less than minimum wage. You have to make up the difference ($1.79 per hour) to bring Ramon’s paycheck to the federal minimum, giving him a weekly wage of $217.60.

To further complicate things, don’t forget overtime pay. To calculate overtime pay for a tipped employee, you would use their regular rate of pay (which includes both their hourly wage and tips) to determine their rate. To make things easy, we’ve created a handy overtime pay calculator.

Consequences of Non-Compliance

Violations of tip credit regulations can cost you. For example, if you fail to pay your tipped workers the minimum direct wage of $2.13 an hour, you’ll be liable for back wages equal to the difference between what you actually paid and what was owed to the employee plus an additional equal amount in liquidated damages. Additionally, employers who violate these rules may also be subject to civil penalties of up to $1,100 per violation.

One case highlights just how costly these violations can be for employers who fail to comply with the law. In 2016, a restaurant group in New York City was hit with more than $4 million in back wages and penalties after an investigation by the U.S. Department of Labor (DOL) found that they had violated the FLSA’s rules governing tip credits. The restaurants didn’t pay their servers the required minimum wage of $7.25 per hour when tips were included; instead, they only paid them $3 per hour plus tips. As a result of these violations, the group had to pay each server more than $6,000 in back wages and penalties. When multiplied by the hundreds of servers affected by the policy, this resulted in a multimillion-dollar judgment against the restaurants’ owners.

The Ins and Outs of Tip Pooling

Tip pooling is another common practice in the restaurant industry, where servers and other tipped employees contribute a portion of their tips to a pot that is then distributed among all of the employees who provide direct table service, such as bussers and hosts. In some states, this practice is permitted; however, it’s illegal in others—including New York State—and, even more confusingly, allowed under certain conditions within those states where it isn’t explicitly outlawed by law or regulation.

While tip pooling can be a great way to promote teamwork and ensure that all employees are fairly compensated, it’s important to ensure that you do it correctly to avoid legal issues.

Under federal law, tips are considered income rather than gratuities; therefore, any money contributed toward tip sharing must come from tips themselves without being deducted from wages first. This means that only those working directly with customers can participate in tip pools; managers and other non-customer-facing staff members don’t qualify unless they actually receive some form of compensation based on customer satisfaction (such as bonuses).

Best Practices for Tip Credits and Tip Pooling

Here are some suggestions to help ensure compliance with tipping regulations while maximizing your savings:

  • Train your staff: Make sure your employees understand the regulations surrounding tip credit and tip pooling, and ensure they are aware of their rights. Provide training on recordkeeping and time tracking to prevent errors and help ensure compliance.
  • Monitor tip pooling: Keep an eye on your tip pooling practices to make sure they comply with regulations. Remember that tip pooling can only include employees who customarily and regularly receive tips, and that management and supervisory personnel cannot participate.
  • Track employee hours and tips: Keep accurate records of your employees’ hours worked and tips received to ensure that you are calculating tip credit correctly. Be diligent when calculating total hours worked during non-tipped duties such as training, cleaning, and other tasks not related to customer service activities.

Forms for Filing Federal Taxes

If you’re taking advantage of tip credits, there are a few different forms you’ll need to use when filing federal taxes. Here’s a brief overview:

  • Form 8027: Employers who operate large food or beverage establishments (generally those with more than 10 employees) must file Form 8027 to report their total sales, charged tips, and total tips for the year. This information is used to calculate the employer’s share of FICA taxes and to ensure that employees are reporting their tips accurately.
  • Form 8846: Employers who take advantage of the Work Opportunity Tax Credit (WOTC) for hiring employees from certain targeted groups, including food and beverage employees, must file Form 8846 to claim the credit.
  • Form 941: Employers must file Form 941 every quarter to report their employees’ wages, tips, and withholding taxes. This form is used to ensure that employers are paying the correct amount of payroll taxes and to reconcile any discrepancies between the employer’s records and the employees’ records.

How Paycor Helps Restaurants

Staying compliant with tip credits, minimum wage laws, and the FLSA is essential for running a successful restaurant. By understanding how tip credits work, complying with minimum wage laws, and creating a positive work culture, you can attract and retain top talent while avoiding potentially crippling legal judgments. For busy restaurant managers, owners and operators, our intuitive and easy-to-use payroll software can keep you compliant while making inaccuracies easy to catch. That’s why more than 4,800 restaurants depend on our solutions every day.