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March 15, 2017
Tips for Compensating Tipped Employees
By Michael J. Modl

If your business employs workers who receive tips as part of their compensation, such as waitstaff, bartenders, or delivery drivers (e.g., pizza delivery drivers), a separate set of rules governs how you compensate them.

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tipsWage and hour lawsuits by tipped employees are on the rise. Like other wage and hour claims, lawsuits by tipped employees can be devastating to a business if they're brought on a classwide basis. Below is a summary of the law and some tips for avoiding liability.

General Rules

The Fair Labor Standards Act (FLSA) permits employers to take a tip credit toward their minimum wage obligations for tipped employees. A tipped employee is an employee who customarily and regularly receives more than $30 per month in tips. Employees must meet the $30-per-month federal threshold regularly, not sporadically. For example, employees who receive tips only during the holidays (e.g., at Christmas and New Year's) aren't tipped employees for purposes of allowing their employer to take advantage of the tip credit.

Federal law is clear that tips belong to employees, and workers must be allowed to retain all tips, unless there's a valid tip pool. Mandatory service fees are not considered tips for purposes of the tip credit, but when they're paid to employees, they may count toward tipped employees' direct cash payment.

Tip credit litigation is costly as well as bad for business. Taking advantage of the tip credit—and using tip pools or tip-sharing arrangements—creates a minefield for employers. Failing to comply with all of the federal law requirements can result in loss of the tip credit and liability for the differential between the direct cash payment and the minimum wage for tipped employees.

Frequently, litigation over tips is brought as a collective or class action, resulting in substantial potential liability, including double damages (liquidated damages) under federal law. Penalty provisions under Wisconsin law, for example, vary from double damages (if the employee first files a complaint with Wisconsin's Labor Standards Bureau) or half again as much as the wages owed (if the employee doesn't file an administrative complaint first).

Tip Credit

Under the FLSA, an employer can take a tip credit toward its minimum wage obligation for tipped employees, equal to the difference between the required direct cash wage and the minimum wage. For Wisconsin employers, the required direct cash wage is at least $2.33. The maximum tip credit allowed is the difference between the minimum wage of $7.25 and the direct cash wage of $2.33, or $4.92.

Those amounts vary slightly from the amounts under the FLSA, which sets the direct cash wage at a minimum of $2.13 and a maximum tip credit of $5.12 (the federal minimum wage of $7.25 minus the direct cash wage). Wisconsin employers are required to comply with the higher direct cash wage rather than the federal amount.

Employers can take the tip credit only for tips actually received by tipped employees. So, for example, if an employer took the $4.92-per-hour tip credit for an employee for a 40-hour week ($196.80), but the employee's actual tips were only $150, the employer must pay the employee the difference in cash for that workweek ($46.80). Failure to do so could result in loss of the tip credit. In short, an employer cannot take a tip credit for more than the actual tips received by the employee.

Also, employers can take a tip credit only if they provide notice to their tipped employees. The notice can be written or oral, but the U.S. Department of Labor's (DOL) Wage and Hour Division (WHD) takes the position that the notice should be provided in writing. The notice must be provided to tipped employees before the employer takes the tip credit and should include the following information:

  • The amount of the direct cash wage the employer is paying the tipped employee (which must be at least $2.33 per hour, in Wisconsin);
  • The amount that the employer will be claiming as a tip credit;
  • Acknowledgment that the tip credit claimed by the employer cannot exceed the amount of tips actually received by the tipped employee;
  • Acknowledgment that all tips received by a tipped employee are to be retained by the employee unless there is a valid tip-pooling arrangement, which must be limited to employees who customarily and regularly receive tips; and
  • Affirmation that the tip credit will apply only to tipped employees who are informed of the tip credit provisions noted above.

Failure to comply with the notice requirements can result in an employer not being permitted to take the tip credit and being required to pay tipped employees the difference between the direct cash wage and the minimum wage. If any information changes (e.g., the amount of the tip credit taken by the employer), a new notice must be provided.

It is the DOL's position that tips belong to employees, even if no tip credit is taken. That means that even if an employer pays a minimum wage cash payment to tipped employees, it cannot require them to turn over their tips. Additionally, an employer cannot require tipped employees who participate in a mandatory tip pool to share tips with coworkers who are not customarily and regularly tipped (e.g., dishwashers and cooks). This issue is currently before the U.S. Supreme Court.

In addition to possibly losing the tip credit for engaging in the conduct described above, employers may face administrative investigations by state or federal agencies. An investigator can look at issues beyond those involving tipped employees, such as independent contractor issues. The DOL will always seek back pay for a three-year period for violations of the FLSA.

Certain deductions cannot be made from wages if they will reduce the employee's cash (nontip) wage below the minimum direct cash wage. For example, if a Wisconsin employee's direct cash wage is the minimum $2.33 allowed under state law and her employer deducts for uniforms, her wage rate will be reduced below minimum wage, resulting in a wage and hour violation.  

Also remember that Wisconsin has a specific statute that prohibits most deductions from employees' wages for things like faulty workmanship or lost or stolen property. Under Wisconsin law, an employer may take a deduction for meals or lodging provided to employees (up to a specific maximum dollar amount), even though it may result in the employee falling below the direct cash wage.

The tip credit is available only for tipped duties or duties related to the primary tipped duties. For example, a waitress may make coffee, clean tables, or make toast, and the hours she spends performing those related duties will be subject to the lower minimum wage, with the employer taking a tip credit. However, if a tipped employee spends more than 20 percent of her time in a workweek performing related duties (e.g., eight or more hours in a 40-hour workweek), the employer cannot take a tip credit for those hours and must pay her a cash minimum wage for that work time.

Moreover, an employer may not take a tip credit for hours spent by a tipped employee performing duties unrelated to the primary duties of the tipped employee. For example, a waiter who is required to perform maintenance duties must receive a cash payment equal to at least the minimum wage for his maintenance duties. The employer cannot take a tip credit for those hours, and the 20 percent rule described above doesn't apply in this situation.

Wisconsin has a separate requirement for employers of tipped employees that wish to take a tip credit. The employer must have a "tip declaration" signed by the tipped employee for each pay period in which it elects to take the tip credit. Without the signed declaration, the employer cannot take the tip credit, unless the employee refuses to sign the declaration. The declaration must state the amount of tips received by the employee on a daily, workweek, or pay-period basis. The employer should document if an employee refused to declare her tips.

Tip Pools

As we mentioned, the general rule is that tips belong to tipped employees, not the employer. The exception to the rule is that an employer may have a valid mandatory tip pool. To be valid, the tip pool must comprise only employees who regularly and customarily receive tips. If other employees share in the tip pool, it is invalid, and the employer will lose the tip credit for its tipped employees and must pay them the full minimum wage in cash.

Which employees regularly or customarily receive tips is a very fact-specific determination, with the key component being that the employees must have customer contact. The cases and guidance from the WHD make clear that it's appropriate for employees in the front of the restaurant who are not managers to share money in the tip pool, but participation is not appropriate for employees in the back of the house.

For example, dishwashers and cooks do not regularly and customarily receive tips and therefore cannot share in money from a tip pool. Managers and supervisors who primarily oversee other employees also shouldn't receive money from a tip pool.

It's appropriate for employers to establish how tips in a valid tip pool are to be redistributed. Tipped employees must be given advance notice of the tip pool provisions if a portion of their tips are to be included in it. An employer cannot take a tip credit on tips that are paid into a tip pool and distributed to employees other than the tipped employees who paid into the tip pool.

The U.S. Supreme Court is currently considering the validity of a tip pool in which all tipped employees receive a direct cash amount at or above the minimum wage but are required to pay into a tip pool that's distributed to employees who aren't customarily or regularly tipped employees (back-of-the-house employees such as dishwashers).

Tip Sharing

The FLSA does not prohibit employees from sharing tips with other employees, including workers who are not customarily and regularly tipped. The tip sharing must be completely voluntary, however, and there can be no form of employer coercion.

There can be no formalized employer arrangement for such tip sharing, and tip sharing cannot be a condition of employment. An employer cannot be part of a tip share. If the tip-sharing arrangement doesn't satisfy those criteria, the employer may lose the tip credit.

The employer cannot play any role in the distribution of tips under a tip-sharing arrangement. If the tip-sharing arrangement is valid, the employer cannot use the shared tips not received by a contributing tipped employee as part of the tip credit for the employee. It's acceptable for an employer to recommend or suggest a percentage for employees to share and with whom.

Takeaways

Here are some things to remember if you have tipped employees:

  • Never take a tip credit that's larger than the tips actually declared by an employee in a workweek.
  • If you permit tip sharing, make certain you are in compliance with the rules governing such arrangements.
  • If you take a tip credit, make certain that you provide written lawful notice to your tipped employees.
  • If you have a mandatory tip pool, make certain that tips from the pool aren't distributed to individuals who aren't customarily and regularly tipped.
  • Be sure to pay tipped employees at the full minimum wage (i.e., don't take a tip credit) for all duties she performed in a workweek that were unrelated to her primary tipped duties.
  • Have your tipped employees declare tips they received on either a daily or a workweek basis.

Mike Modl is a partner with Axley Brynelson, LLP and an editor of Wisconsin Employment Law Letter. He can be reached at 608-283-6702 or mmodl@axley.com.

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