The simple act of tipping has become a serious legal concern for the restaurant and other hospitality industries. As the Department of Labor’s enforcement efforts increase and private wage and hour lawsuits explode, these industries are prime targets for tipped employee violations. To further complicate matters, effective January 2014, the IRS implemented new guidelines for tips and service charges. Foodservice employers must ensure compliance with applicable laws. This article will attempt to untangle the web of laws and regulations and provide some practical “tips” for employers.
The ground rules
All nonexempt employees must be paid the minimum wage under federal (currently $7.25) and state law (varies). A recent White House report promoting a substantial jump in the federal minimum wage has prompted renewed discussion about how tipped employees are compensated. Under the federal Fair Labor Standards Act, tipped employees are those who regularly receive more than $30 per month in tips. The Department of Labor’s position is that tips are the sole property of the tipped employee and that any arrangement between the employer and the tipped employee, whereby any part of the tip received becomes the property of the employer, is unlawful.
The tip credit provisions of the FLSA permit an employer to pay tipped employees no less than $2.13 per hour in cash wages and take a “tip credit” equal to the difference between the cash wages paid and the federal minimum wage. The tip credit may not exceed the amount of tips actually received and, under the current minimum wage, may not exceed $5.12/hour (the difference between the federal minimum wage of $7.25 and the minimum tipped wage of $2.13). For example, under federal law, an employer can pay a tipped employee $2.13/hr and take a “tip credit” of $5.12/hour, provided the tipped employee makes sufficient tips to cover the tip credit. If the employee does not earn sufficient tips for the tip credit, the employer must make up the difference to ensure the employee receives minimum wage for all hours worked. Employers must keep clear records to demonstrate proper application of the tip credit.
If an employer elects to use the tip credit provision, the employer must:
- provide specific information to each tipped employee about the tip credit amount and other required information
- allow the tipped employee to retain all tips, except to the extent that there is a valid tip pooling arrangement
- be able to show that the employee receives at least the minimum wage by combination of direct wages and the tip credit claimed
When an employee performs both tipped and nontipped duties, such as waiting tables one day and washing dishes the next, the tip credit is available only for the hours worked in the tipped position. A tip credit may be taken, however, for time spent in duties incidental and related to the tipped position, such as preparatory and closing activities, if the tipped employees do not spend more than 20 percent of their time on such incidental duties.
The use of the tip credit also can be complicated by state laws. Some states forbid the use of tip credits, while others impose significant record-keeping and/or notice requirements on their use.
Some employers might be tempted to not require employees to report tips under $30/month or report tips beyond what brings them up to the amount of the tip credit taken. Both of these practices are flawed and could create tax liability.
To complicate matters further, the definition of a tipped employee for purposes of IRS reporting differs from the FLSA. The IRS defines a tipped employee as one who earns $20 or more per month in tips. Under IRS rules, employees must report to their employer the total amount of tips they receive and provide the employer with written reports by the 10th of the following month. Employees who receive tips of less than $20 in a calendar month are not required to report their tips to their employer, but must report these amounts as income on their tax returns and pay necessary taxes.
Therefore, even if an employee is not deemed a tipped employee under the FLSA, per the IRS the individual may still be considered a tipped employee for purposes of reporting the income generated by tips. The best practice is to simply require employees to report all tips.
Service charges, automatic gratuities
There’s been a lot of discussion recently about the handling of service charges and automatic gratuities. A tip is given by the customer free from compulsion. The customer has an unrestricted right to determine the amount, the payment is not subject to negotiation or dictated by the employer and the customer generally has the right to determine who receives the payment. Tips include all cash given to the employee, whether directly from a customer or a tip pool, as well as tips charged on credit or debit cards. Employers must withhold payroll taxes from the tip amount reported (i.e. Medicare, Social Security and income taxes). Other than to take a tip credit for the proper amount, an employer cannot retain any of the tip.
A service charge or automatic gratuity is a compulsory fee. Service charges often come in the form of banquet fees or automatic gratuities added to the bill for large tables. Service charges and automatic gratuities are generally considered part of the business’s gross receipts. Businesses may pay wages from these service charges, but cannot under any circumstance take a tip credit using a service charge. But, while service charges are not tips, they can be wages.
A service charge can be considered wages if any portion of the service charge is given directly to the employee in addition to their hourly wage. If a restaurant charges a 15-percent gratuity (service charge) to a party of eight or more and gives the server 5 percent of that fee, that amount must be reported as income to the IRS and factored into the regular hourly rate for the week for purposes of calculating overtime under the FLSA. Here’s an example:
A banquet server makes $10 per hour and works 45 hours in one week, plus receives $200 from the service charges for that week. The employer pays the straight time of $450 for the 45 hours, but the overtime rate for the five additional hours is $7.22 an hour, not $5 an hour. Instead of getting $25 in overtime, the server receives $36.11. The total paycheck before taxes is $486.11. Had the server not received the service charges, the total paycheck would be $475 before taxes.
While the difference in pay may appear insignificant, it is not in the eyes of the law, or the employee.
Audit pay practices
Foodservice employers should audit their pay practices at least annually to ensure compliance with federal, state and local laws. Legal and tax professionals who are well-versed in this area can help find and correct any mistakes before a government agency or plaintiff’s lawyer finds them.
Andria Lure Ryan is a partner at Fisher & Phillips, LLP, and can be reached at [email protected] or 404-240-4219. This article generally discusses issues related to employers’ treatment of tips, service charges and automatic gratuities. The article is not intended as legal or tax advice, and any specific question regarding a particular policy or rule for your workplace should be addressed with legal counsel to ensure compliance with all applicable federal and state laws.