Restaurant Tipping Laws [Federal + State]

By Megan Johnson

Feb. 4, 2022

Business owners in the restaurant industry are in a unique position when it comes to employee tips. As an employer, it is important to create a fair system for employees that makes sure employees are rewarded for their service, and also comply with IRS regulations.

There are a lot of nuances when it comes to federal and state wage laws and restaurant owners have a responsibility to implement policies that are legal yet rewarding for staff. Consider these two strategies to ensure your business remains fair but compliant.

What are tips?

Tips are optional payments received by employees from customers, typically in exchange for good service. Tips make up a large part of earnings as approximately $36.4 billion is earned in tips by tipped workers annually. A tipped employee is an employee that earns more than $30 a month in tips.

What does the law say about tips?

The law around tips differs on the federal, state and local levels. However, there are characteristics that remain the same throughout:

  • A tipped employee is an employee that earns more than $30 a month in tips
  • Employees who do not earn tips —also known as “non-tipped employees” (cooks, cleaners, dishwashers etc) must be paid the minimum wage
  • Tips are considered wages
  • Tips are strictly the property of the employee— there is no legal arrangement where an employer receives part of an employee’s tips. This is considered wage theft.

Federal Law

Federal law concerning tips is dictated by the Fair Labor Standards Act (FLSA) as mandated by the Department of Labor (DOL). This law tackles wages, work hours and minimum wage requirements.

You are required to pay $2.13 per hour in direct wages on the basis that what your employee earns in tips will equal the federal minimum wage. For example, your waiter works 30 hours a week and receives $200 in tips for that week. Your employee’s earnings look like this: $2.13 x 30= $63.90 ( which is called the cash wage) plus the tips of $200, which brings the total to $263.90. Their hourly wage works out to $8.79, (earnings divided by total hours) which exceeds the federal minimum wage.

In another week, your waiter works a 30-hour week again, but this time only receives $100 in tips. The waiter’s earnings look like this: $2.13 x 30=$63.90 plus the tips of $100, making the total $163.90. The hourly wage is $5.46. This does not exceed the federal minimum wage, so you must pay the waiter a tip credit to fill the gap and fulfill the minimum wage requirement ($7.25).

Tip crediting is the process of applying the tips towards your employee’s wage to ensure you are paying the full amount. In the example above, the $5.46 hourly pay does not meet the minimum wage, so the employer must fill that gap by paying the waiter an additional $1.79 per hour.

State Law

It is always important to check your local state laws on the Department of Labor (DOL) website.

Some states such as Minnesota, Oregon and California —do not allow tip credits under any circumstances. In California, the minimum wage is $14 per hour for employers that have more than 26 employees and $13 per hour for employers with 25 and below employees. Employers in these states must pay the full state minimum wage to their employers. Therefore your employees receive tips on top of their wages.

Although wage laws require employers to ensure that employees’ tips bridge the gap to make the $7.25 per hour minimum wage, it may improve employee morale and reduce turnover to go beyond that rate of pay. Especially now, when there’s a labor shortage, attracting restaurant employees is difficult and workers are demanding better working conditions. It’s not uncommon to see workers walking out or refusing to work for such low wages.

How are taxes reported on tips?

Tips are subject to employment taxes including Federal Insurance Contributions Act, (FICA), Federal Unemployment Tax Act, (FUTA) and Federal income tax withholding. This makes you liable for different payroll and tax obligations. You must pay the employer’s portion of FICA and FUTA taxes. This can influence your decision on which tipping policy to implement for your staff. Here’s the basics of tax reporting on tips:

  • Your employees are responsible for reporting all cash tips to you if they exceed over $30 and this must be done by the 10th of the following month of when the tips were received. For example, a waitress earned $550 in tips in February, so this needs to be reported to the manager by March 10th.
  • It is important you create an open environment for your employees to declare their tips to you, so you can fulfill these tax obligations.
  • If your employee refuses to report their tips to you, you are not liable for the employer’s share of FICA until the IRS is notified.

What are the options for tip policies in restaurants?

As a restaurant owner, here are three tip policies you could implement:

Everyone keeps their tips

Each employee keeps the amount of tips they earned at the end of the shift. Whilst this is a straightforward policy, it can be considered unfair. Only customer-facing staff (waitstaff and bar staff) would receive tips, this excludes back of house staff like dishwashers and bussers—who are also integral to the hospitality industry. This policy could lead to less back of house employees as they do not see any extra benefits.

Tip splitting or tip sharing

Tip splitting involves splitting the tips between tipped and non-tipped employees based on hours worked or by role-based percentages. Tip sharing is voluntary and there are no guidelines or laws. This policy ensures all employees receive tips, creating a fair environment.

Tip splitting can be confusing from a payroll perspective because you have to ensure your non-tipped employees receive the minimum wage plus their tips (which will also be taxed). Plus you have to ensure that you are applying the correct tip credits to the tipped employees’ wages even though their tips are being split. You also want to ensure that the non-tipped employees are not out-earning the employees who actually earn the tips due to the tip credit rules.

Tip pooling

Tip pooling consists of collecting the tips earned during a shift and evenly distributing the tips at the end of the shift. The tip pool is shared between both front and back staff.

Tip pooling is covered by the FLSA. You cannot apply a tip credit to employees’ wages who share tips with non-tipped staff, therefore you must pay the full minimum wage. For instance, normally you can apply a tip credit to the front-of-house staffs’ wages. But if they are part of a valid tip pool agreement where they will be sharing their tips with back of house staff, you cannot apply tip credits.

This policy is equitable, employees receive a fair hourly wage and the tips are also shared amongst all employees. But tip pooling may not be a sustainable solution when there are slow periods and you are operating with less turnover. Your staff may be disappointed that their tips are being split when there are fewer tips going around.

Which is best: tip splitting or tip pooling?

From a compliance perspective, tip pooling may be the best option. It is easy to calculate the tips and wages—you can easily keep up with your employee earnings. Everyone is earning the minimum wage plus tips, there are no calculations for tip credits.

A tip pooling policy also might help you attract staff—you are offering a benefit to prospective employees. A fair wage plus the potential of earning tips for all staff. However, it might be a good idea to let your employees choose which policy they want to be implemented. This gives your staff a voice and agency to set the conditions that they want to work under.

Manage tip calculation headaches

Whichever policy you decide to implement, the bad news is there are some calculations waiting for you. The good news is, workforce management software can help. Oftentimes you can connect it to your POS system, set the percentage of tips to be shared, and your employees automatically get what they’re owed based on hours worked. Learn more about how proper time and attendance tracking can help you manage tip calculations by contacting us. We’d love to talk you through it.

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