A couple of weeks ago, a Philadelphia based sports bar chain entered into a consent order with the U.S. Department of Labor (DOL) and filed a request with the E.D. Pennsylvania for approval of a separate settlement with individual affected employees who alleged the employer improperly took tips from servers and violated the Fair Labor Standards Act’s (FLSA) minimum wage, overtime, and record-keeping requirements. All told, the employer ponied up over $8.4 million to settle these allegations.

Tipped employees are entitled to receive at least minimum wage. Consequently, if application of a tip credit or a mandatory tip pool leaves the employee short of minimum wage, there is a problem and potentially great exposure. Because the cost of getting it wrong can be steep, now is the time for employers in the service and hospitality industries to review the deceptively simple rules associated with compensating tipped employees under the FLSA. Accordingly, here is a summary of the basics:

Who are Tipped Employees?

Tipped employees are those who customarily and regularly receive more than $30 per month in tips. To customarily and regularly receive tips, the employee must do so more than occasionally, but it may be less than constantly. Servers, counter personnel who serve customers, bussers, bartenders, and bellhops perform important customer service functions and are typically recognized as tipped employees. On the other hand, dishwashers, chefs, and expeditors are not. (29 U.S.C. § 203(t); 29 C.F.R. § 531.57).

The Tip Credit

The Amount of the Credit. The FLSA allows an employer to take a partial offset against its minimum wage obligations to a tipped employee provided that certain requirements are met. However, it is important to note that not all states allow an employer to take a tip credit.

Under Section 3(m) of the FLSA, the tip credit is equal to the difference between the wage paid to the employee (which must be at least $2.13) and the federal minimum wage.  Consequently, the maximum tip credit that an employer can currently claim is $5.12 per hour (the minimum wage of $7.25 minus the minimum required cash wage of $2.13).

Required Advanced Notice To Employee. To be able to take the tip credit, an employer must provide the employee with advanced notice and adhere to the requirements set forth in the notice. While notice can be written or verbal, employers should memorialize that notice was provided in writing. As set forth by the DOL, the notice must inform the employee:

  1. of the amount of the cash wage the employer is paying the tipped employee, which must be at least $2.13 per hour;
  2. of the additional amount claimed by the employer as a tip credit, which cannot exceed $5.12 (the difference between the minimum required cash wage of $2.13 and the current minimum wage of $7.25);
  3. that the tip credit claimed by the employer cannot exceed the amount of tips actually received by the tipped employee;
  4. that all tips received by the tipped employee are to be retained by the employee except for a valid tip pooling arrangement limited to employees who customarily and regularly receive tips; and
  5. that the tip credit will not apply to any tipped employee unless the employee has been informed of these tip credit provisions. (29 C.F.R. § 531.59(b)).

Failure to provide the required information disqualifies use of the tip credit, and the employer must pay the tipped employee at least the minimum wage rate and allow the tipped employee to keep all tips received.  (DOL Fact Sheet #15).

Employers using the tip credit must be able to show that tipped employees received at least the minimum wage when their wages and the tip credit amount are combined. If the combined amount does not equal the minimum hourly wage, the employer must make up the difference.

Dual Job Employees

If an employee works in both a tipped and a non-tipped position, the tip credit is available only for the hours spent working in the tipped position (e.g., a waiter who also works in maintenance for a hotel). Additionally, although tipped employees are permitted to perform non-tipped duties related to the tipped position, if the tipped employees spend more than 20% of their time performing non-tipped activities, no tip credit may be taken for time spent in such duties. (DOL Handbook § 30d00(e); DOL Fact Sheet #15; see Fast v. Applebee’s Int’l, Inc., 638 F. 3d 872 (8th Cir. 2011), cert. denied, 132 S. Ct. 1094 (2012)). Non-tipped activities include things such as cleaning and setting tables, making coffee, cleaning restrooms, and washing dishes or glasses.

Tip Pooling

A Valid Tip Pool. The FLSA does not prohibit a valid tip pooling arrangement among employees who customarily and regularly receive tips. 29 U.S.C. § 203(m).  Tip pooling involves requiring tipped employees such as servers and bartenders to contribute a portion of their tips to pool for redistribution among a larger group of employees.

The FLSA does not impose a maximum contribution amount or percentage on valid mandatory tip pools. However, the employee must receive at least the minimum wage per hour worked regardless of the tip pool contribution.

In addition, the DOL states that in order to be a valid tip pool, (1) the employer must notify its employees of any required tip pool contribution amount, (2) may only take a tip credit for the amount of tips each employee ultimately receives, and (3) may not retain any of the employees’ tips for any other purpose. (29 C.F.R. § 531.54; DOL Fact Sheet #15). Though not required, this notice should be provided to the employees in writing.

Who Can Participate. One area that has spurred significant litigation in the tip pooling area is the issue of who can participate in a tip pool. The FLSA makes clear that anyone fitting the definition of an “employer” cannot participate. An employer is “any person acting directly or indirectly in the interest of an employer in relation to the employee.” 29 U.S.C. § 203(d)). This will typically include any owners and higher level managers. However, in determining whether an individual such as a shift supervisor or other supervisory-level employee could be considered an employer, courts utilize an economic realities test. This test reviews whether the employee: (1) has the power to hire and fire; (2) can control work schedules or conditions of employment; (3) determines the rate and method of employees’ pay; and (4) maintains employment records. Inclusion of an “employer” in the tip pool will render the tip pool invalid.

In addition to employees meeting the definition of “employer,” the DOL states that a valid tip pool may not include employees who do not customarily and regularly receive tips such as dishwashers, cooks, chefs, and janitors. (DOL Fact Sheet #15). This also has been the subject of litigation and question, particularly after the Ninth Circuit held in Cumbie v. Woody Woo, Inc., 596 F.3d 577 (9th Cir. 2010) that participation of back of the house kitchen staff who had no in-person interaction with customers only invalidates a tip pool if the employer takes the tip credit against the minimum wage under FLSA section 3(m). In an effort to stamp out the holding in Cumbie, in April 2011, the DOL amended its regulations to provide that “[t]ips are the property of the employee whether or not the employer has taken a tip credit under section 3(m) of the FLSA” (29 C.F.R. § 531.52) and further that “[v]alid mandatory tip pools. . . can only include those employees who customarily and regularly receive tips.” (29 C.F.R. § 531.54).  So far, this effort to overrule Cumbie by regulatory fiat has been flatly rejected by the federal courts.

Some Final Potential Trouble Spots

Service Charges. A compulsory service charge is not a tip. For instance, some restaurants or banquet halls may impose a service charge based on the size of the party being served (i.e. 15% of the amount of the bill).  Service charges are deemed part of the employer’s gross receipts. Amounts distributed to employees from service charges cannot be counted as tips. If an employee receives tips in addition to the compulsory service charge, those tips may be considered in determining whether the employee is a tipped employee and in the application of the tip credit. (29 C.F.R. § 531.55). Also, be cognizant that many states (including NY and MA) have specific requirements regarding service charges.

Credit Card Tipping. Tips on credit cards create another tricky situation. Where tips are charged on a credit card and the employer must pay the credit card company a percentage on each sale, the employer may pay the employee the tip, less that percentage. For instance, if the employer is charged 3% on all sales, the employer may pay the tipped employee 97% percent of the tips on the sales without violating the FLSA (but be aware of state laws prohibiting such a reduction such as Cal. Lab. Code § 351). This charge on the tip may not reduce the employee’s wage below the required minimum wage. Furthermore, the amount due the employee must be paid no later than the regular pay day and may not be held while the employer is awaiting reimbursement from the credit card company. (See Fact Sheet #15).

Overtime Calculation. It is easy to make an error in calculating overtime rates with tipped employees. So remember:

  • A tipped employee’s regular rate includes the tip credit—this means that if an employer takes the tip credit, overtime is calculated using the minimum wage rate (i.e. $7.25 x 1.5 per overtime hour and not $2.13 x 1.5).
  • Note, however, that “[a]ny tips received by the employee in excess of the tip credit need not be included in the regular rate. Such tips are not payments made by the employer to the employee as remuneration for employment within the meaning of the Act.” 29 C.F.R. § 531.60.
  • Be sure that the regular rate used to calculate overtime includes all remuneration earned by the employee during the workweek (i.e. service charges, commissions).

Key Takeaways

  • Tipped employees must make minimum wage for hours worked.
  • If taking the tip credit and/or requiring tip pooling, make sure to provide the required advanced notice and do it in writing.
  • The DOL’s amended regulations will be enforced by the DOL in every jurisdiction but the states in the Ninth Circuit.  Though federal district courts consistently have been holding that the regulations are invalid because the restrictions in FLSA section 3(m) are tied to an employer taking the tip credit, employers must be cognizant of the requirements of the regulations as this issue winds its way through the courts.
  • Remember to consider applicable state law requirements on compensating tipped employees.