The Tip Credit & Tip Pooling Pitfalls

In the past year, there has been a sharp increase in lawsuits claiming that service industry employers are violating the Fair Labor Standards Act (“FLSA”) by not properly paying their tipped employees minimum wages and overtime.  Large numbers of hotels and restaurants in high tourism areas such as New York and Florida are now facing expensive litigation battles over the way in they pay tipped employees. The unfortunate problem is that many of these employers are following industry standards which violate the law, even if only technically.  Employers tend to believe that they are in compliance because “that’s how it is done in the industry.” In this case, however, there is no “safety in numbers”. Since this type of FLSA claim has become so prevalent, it is imperative that restaurants and other service industry employers claiming a tip credit understand the nuts and bolts of the tip credit. 

 Under the FLSA, employers may pay tipped employees less than the federal minimum wage if the tips received are sufficient to make up the difference between the wages paid by the employer (“direct pay”) and the federal minimum wage.[1]  The difference between the direct pay and the minimum wage is called a “tip credit.”  A “tipped employee” is an employee “engaged in an occupation in which he customarily and regularly receives more than $30 a month in tips.”  29 U.S.C. §203(m).  Currently, the FLSA allows employers to take a maximum tip credit of $5.12 and pay the tipped employee at least $2.13 per hour.  Federal law requires that tipped employees keep all of their tips but does allow “tipped employees” (and only tipped employees) to pool or share their tips with each other. 

 Top Tip Pool Pitfalls To Avoid

 1.  Management Cannot Share In The Tip Pool

 Employers and supervisors cannot share the employees’ tips under any circumstances.  Any employee, regardless of title, that performs the supervisory functions may not benefit from tips. 

 2.  Only Tipped Employees May Share In The Tip Pool

 To be considered a tipped employee that “customarily and regularly” receives tips, the employee must have sufficient direct customer interactions to warrant benefiting from the tip provided by the customer.  Waitresses, bus boys and service helpers can participate in the pool.  The DOL, however, prohibits dishwashers or laundry room attendants from sharing in the tip pool.

 3. Percentage of Tips Shared Cannot Decrease Employees Below Minimum Wage

The tip pool cannot reduce the wages of the tipped employee below the direct minimum wage.  According to the DOL Wage & Hour Division, employers cannot require employees to pool tips in excess of 15% of the individual employee’s tips.[2]  When using percentages of overall sales as the benchmark for distribution of a tip pool, the key is not to require the employee’s contribution to exceed 15% of the total tips received by the employee.[3]

 4.  Employers Must Comply With Notice Requirements

 Many employers who validly claim the tip credit do not appropriately notify their employees about it.  When an employer elects to use the tip credit, the employer must:

 (a) Notify each tipped employee about the tip credit before the credit is utilized;

 (b) Prove that the employee is receiving at least minimum wage when the direct pay is aggregated to the tip credit; and

 (c) Allow the tipped employee to retain all tips unless there is a valid tip pooling system in place. 

One way to satisfy the notice requirement is to prominently display a DOL poster which includes a section on tip credit.  Alternatively, employers may have employees sign an acknowledgment form that specifies that the employer is aware that the employer is taking a tip credit against the minimum wage as permitted by federal and/or state law. 

 5.  Employers Cannot Take Improper Deductions From Minimum Wages

Employers cannot deduct the costs of uniforms, walk-outs, breakages of equipment, or cash register shortages from the minimum wages of tipped employees.         

6. Employers Must Correctly Calculate Overtime For Tipped Employees

 When tipped employees work overtime hours, employers must be careful to calculate and pay overtime wages based on the employee’s correct hourly rate.  In other words, overtime must be calculated based on the employee’s full minimum wage (currently $7.25 under the FLSA) and not based upon the employee’s reduced hourly wage (that reflects the tip credit). Only after overtime wages are calculated using the employee’s full minimum wage can employers subtract the total tip credit from the wages due.

 7. Employers Must Comply With State Tip Credit/Tip Pool Laws

Not to run afoul of state law, employers must be familiar with the laws enforced in their area.  Several states forbid or limit the amount of tip credit an employer can claim.  For example, employers in Alaska, California, Oregon and Washington cannot claim a tip credit.  Florida does not allow an employer to claim more than $3.02 for a tip credit.  Depending on job title and description, New York employers are entitled to claim a tip credit that ranges from $1.10 through $2.90.  Thus, familiarity with local laws is needed. 

 What happens if the tip credit or tip pool regulations are violated?

 If tip credit or tip pool regulations are violated, employers may forfeit the tip credit for both wage and hour and IRS purposes.  From a wage/hour perspective, employers may be responsible for the paying “tipped” employees their full minimum wages going back two years (or three years for willful violations).  From an IRS perspective, employers would be responsible for back taxes as well as contributions to the employees’ social security benefits. 

[1] U.S. Dep’t. of Labor. Fact Sheet #15 Tipped Employees Under the Fair Labor Standards Act (FLSA) (hereinafter “DOL #15”). 

[2] Dep’t of Labor Field Operations Handbook (2000), (hereinafter “FOH”) H30(d)(04)(b).  See also, Opinion Letter WH-380 (March 26, 1976). 

[3] Opinion Letter WH-468 (September 5, 1978).


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