Restaurants are Prime Targets for FLSA Lawsuits: 6 Tips for Employers Relying on the Tip Credit

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PilieroMazza PLLCThe COVID-19 pandemic has been particularly difficult for the food and beverage industry.  With stay-at-home orders, operational capacity restrictions, and indoor dining limitations imposed on restaurants and bars across most of the country throughout 2020 and into 2021, the impact has been significant.  The hospitality industry lost hundreds of billions of dollars in anticipated revenues; beloved local eateries closed their doors temporarily or permanently; and millions of restaurant workers lost their jobs or left the hospitality industry altogether.  Now, as the number of fully vaccinated individuals increases daily, state and local governments begin to consider relaxing restrictions on social distancing and operational capacity, and the public becomes more comfortable with eating out and socializing, the hospitality industry may be moving slowly toward recovery.  As the food and beverage industry rebuilds, restaurants and bars must be cognizant of their obligations to employees under the Fair Labor Standards Act (FLSA); even minor mistakes in employee pay practices, including the use of the tip credit, can lead to significant liability and financial disaster.

Anyone working in the food and beverage industry is likely aware of how servers and bartenders are typically paid by the restaurants and bars that employ them.  Under federal and most state laws, employers may pay servers and other tipped employees an amount well below the standard minimum wage—currently $2.13 per hour under federal law—provided that the employer makes up the difference with tips earned by and paid to the employee.  This practice is called taking the “tip credit,” i.e., an employer can credit tips received by the employee against the employer’s obligation to pay the full federal and state minimum wage.  What many people—including employers of tipped workers—do not realize is an employer must meet certain requirements under the FLSA before it can take the tip credit. 

The tip credit is a nuanced and complicated concept with many pitfalls for employers.  Failing to strictly adhere to these requirements can invalidate the tip credit altogether and may expose the employer to federal FLSA or state wage-and-hour litigation and significant unpaid wage claims, liquidated damages, and attorneys’ fees, even where the employees ultimately received more than the required federal and state minimum wage. Given the complexities of the statute and regulations implementing the tip credit, restaurants and bars are particularly susceptible to mistakes in implementation and resulting litigation by aggrieved employees. 

Here are our tips for helping employers remain compliant with their tip credit obligations:

  1. Employees must be notified of how their pay rate is calculated using the tip credit. The statute that authorizes employers to pay tipped employees a lower hourly wage requires that such workers be notified of their wage structure in advance.  Specifically, an employer must notify tipped workers that: (a) the employer intends to utilize the tip credit and treat tips as satisfying part of the employer’s minimum wage obligations; and (b) if the amount of tips plus hourly wages do not match or exceed the applicable minimum wage, the employer must make up the difference.  The notice requirement may be accomplished by providing a verbal instruction, posting a conspicuous and detailed notice in a common area where employees frequently go, or including a statement in an employee handbook.  Importantly, it is generally not sufficient simply to list an hourly rate and the amount of tips earned during the pay period on an employee’s paycheck.  In order to ensure that the tip credit is available to an employer, we recommend that the tip credit notice be posted conspicuously at the restaurant in a well-traveled common area; the notice be provided both orally and in writing to new employees at the time of hire, with employees signing a tip credit acknowledgment form; and the notice be included in an employee manual provided to each employee.  It is important to note that, even if an employer always pays tipped employees more than the applicable minimum wage, it may still be penalized for failing to provide this notice. 
  2. Tips must be properly allocated to tipped employees. In order to take the tip credit, an employer must ensure that a tipped employee retains all tips earned by that employee.  Managers and owners cannot retain any of an employee’s tips, nor can an employee be required to cover a customer’s unpaid tab, make up the difference if a cash register was short, reimburse the restaurant for broken dishware, or contribute a portion of their tips to a worker that does not customarily receive tips.  To ensure an employer  qualifies for the tip credit, they must: set strict rules about allocation of tips to properly tip employees; train the employee responsible for calculating and distributing tips; and keep detailed records of tips coming into the restaurant or bar compared against the tips paid out to tipped employees.
  3. Mind the tip pool. The one exception to the rule that tipped employees must retain all tips earned is where an employer utilizes a valid tip pool.  A tip pool is where all tipped employees combine the tips they received during a given shift, and the total amount of tips received from the team is then distributed among all tipped employees in accordance with a pre-set formula.  In order for a tip pool to be valid and satisfy the requirements of the FLSA, only employees who regularly receive tips, i.e., employees “engaged in an occupation in which [they] customarily and regularly receive[] more than $30 a month in tips[,]” can be included.  In many cases, tip pools that include kitchen workers, managers, dishwashers, or janitorial staff will be considered invalid.  However, the validity of the tip pool must be considered on a case-by-case basis.  To protect the tip credit, employers should impose clear rules for any tip pool, make all tipped employees aware of the rules verbally and in writing, and closely monitor the distribution of the tip pool to ensure it is done properly and in accordance with the law.
  4. Pay attention to overtime hours. Inherently, the nature of the food and beverage industry requires flexibility both for the restaurant or bar itself and for its employees.  As a result, tipped employees may work more than forty hours in a given week by, for instance, picking up extra shifts, swapping shifts with a coworker, or by working late to tend to a table of customers staying at a restaurant after hours.  A tipped employee, like other non-exempt employees, is entitled to receive overtime pay of one-and-one-half times the “regular rate at which he is employed.”  Simple math would tell you the employer must multiply the tipped employee’s regular rate of $2.13 per hour by 1.5 and pay $3.20 for overtime hours (so long as the employee’s tips reach the regular overtime rate of $10.88 per hour); but, simple math would be wrong.  Under the FLSA, the maximum tip credit an employer can take is the regular minimum wage ($7.25) minus the cash wage paid ($2.13), or $5.12.  This maximum tip credit applies equally to overtime hours, meaning that an employer must pay an overtime rate of $5.76 per hour ($10.88 minus $5.12).  Employers must be vigilant about complying with the required pay rates for both regular and overtime hours and maintain detailed records of exact hours worked by employees in order to ensure compliance with the tip credit rules.
  5. Be aware of federal, state, and local obligations. The laws, restrictions, and calculations discussed in this blog represent considerations necessary to comply with the FLSA—a federal law.  But each state, and even some local municipalities, have their own wage payment statutes, with varying obligations for employers.  For instance, minimum wage requirements can vary widely.  Although the federal minimum wage is $7.25 per hour, and all states must pay non-exempt workers at least that amount, the District of Columbia’s minimum wage, effective January 1, 2021, is $15.00 per hour.  An employer can comply with the tip credit requirements of the FLSA while being out of compliance with applicable state-level tip credit requirements.  To take the tip credit, employers should be familiar with and ensure compliance with all applicable statutes and regulations and stay up-to-day with the wage payment requirements that change often.
  6. Understand the penalties. Finally, employers must understand the ramifications of non-compliance with tip credit requirements.  Where an employer violates the tip credit rules, it may be liable for back wages in the total amount of the tip credit taken (i.e., $5.12 per hour, for every hour of work).  And, under the FLSA, an employer that fails to follow applicable laws and regulations can be liable not only for those back wages, but an equal amount of liquidated damages, plus attorneys’ fees.  Many states impose harsher penalties for employers who violate wage payment obligations.  For instance, the District of Columbia Wage Payment and Collection Law permits aggrieved employees to recover a total of four times the back wages, plus attorneys’ fees, from an employer.  The penalties for non-compliance are severe, and employers must be vigilant in their compliance with all applicable statutes.  Even a minor mistake can lead to substantial liability.

By following these tips, restaurant and bar employers will be in an excellent position to stay on the right side of the law and avoid the severe penalties imposed under the FLSA and state wage-and-hour laws. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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