Section 3(m) of the federal Fair Labor Standards Act allows a portion of the employee's FLSA-required minimum wages to consist of tips.  Unfortunately, it is all-too-common for employers to make expensive mistakes where tips are concerned.

Fundamental Rules

Tipped employees are those engaged in occupations in which they customarily and regularly receive more than $30 a month in tips.  Tips they actually receive may be counted as FLSA wages up to a current maximum of $5.12 per hour; the employer must pay them at least $2.13 an hour in addition to tips.  The FLSA requires an employer to tell each tipped employee about the law's tip-credit provisions in advance.  And, as we reported in May, the U.S. Labor Department now says that other notifications are also required.

The employee's creditable-tips-plus-wages total must come to at least the current minimum wage of $7.25; the employer must make up any shortfall.  Employees must be allowed to keep their tips, except that they can be required to contribute to a tip-pool participated in only by other employees who customarily and regularly receive tips.

Pitfalls and Misconceptions

Among the typical problems are:

♦   Failing to provide the necessary tip-credit notification;

♦   Not ensuring that the total of an employee's hourly wage plus his or her creditable tips equals at least the minimum wage; or

♦   Not being able to document that employees actually received enough in tips to cover the credit taken.

Employers also find themselves facing liability for:

♦   Taking the tip-credit for hours a "dual function" employee spends in non-tipped work (learn more here);

♦   Calculating overtime at 1.5 times only the employee's $2.13-per-hour cash wage;

♦   Taking a larger tip-credit for overtime hours than for non-overtime ones;

♦   Withholding uniform costs, shortages, breakage, "walk-outs", and so on from an employee's tips; or

♦   Maintaining invalid tip-pools.

Trouble can also result from lumping both tips and service charges under the catch-all term "gratuity".  An FLSA tip-credit "tip" is a payment the patron decides whether to make, and as to which the patron decides how much to give and to whom to give it.  No tip credit may be taken for a compulsory service charge imposed by the employer.  What's more, service charges paid to employees must be included when figuring any FLSA overtime pay they are due.

What About Other Laws?

Some states do not permit taking a tip-credit, while others allow one but restrict the amounts in ways which are different from the FLSA's provision.  Also, an increasing number of states and other jurisdictions prescribe what employers may, may not, and must do where sums representing tips and service charges or fees are concerned.

Employers should immediately check to see whether tips and tip-credit matters are being handled in the proper way.  Even if things used to be fine, management is not always aware of changes in the law or in day-to-day procedures that can lead to major problems.

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The federal Fair Labor Standards Act's "tip credit" was among the many topics addressed by the U.S. Labor Department's recent Final Rule.  DOL's tip-related pronouncements are a mixed-bag for employers.
 
The General Principles
 
The FLSA's Section 3(m) allows an employer to credit a portion of a tipped employee's tips toward the FLSA-required minimum wage (currently $7.25 per hour).  Employers taking an FLSA tip credit must pay a cash wage of not less than $2.13 per hour, so at present they are limited to a tip credit of no more than ($7.25 − $2.13) = $5.12 per hour.  The FLSA defines "tipped employees" as those who are engaged in occupations in which they customarily and regularly receive more than $30 a month in tips.  For FLSA tip credit purposes, a "tip" is a payment the patron decides in his or her discretion whether to make, and as to which the patron can decide how much to give and for whom to leave it; not all "gratuities" are "tips".
 
Section 3(m) says that an employer may take a tip credit only if (i) the tipped employee has been "informed" by the employer of Section 3(m)'s provisions; and (ii) the employee has retained all of the tips he or she received, except for amounts pooled among employees who customarily and regularly receive tips.
 
What Does "Informed" Mean?
 
DOL's position is that an employer must tell the employee that it intends to take a tip credit and must also specifically notify the employee in advance:
 
♦   Of the amount of the direct cash wage the employer will pay to the employee;
 
♦   Of the amount the employer is taking as a credit against tips received, which cannot exceed the difference between the FLSA minimum wage and the actual cash wage the employer pays the employee;
 
♦   That the additional amount the employer claims as a tip credit may not exceed the value of the tips the employee actually receives;
 
♦   That the tip credit shall not apply with respect to any tipped employee unless the employee has been informed of Section 3(m)'s tip-credit provisions; and
 
♦   That all tips the employee receives must be retained by the employee, except for the pooling of tips among employees who customarily and regularly receive tips.
 
DOL says that the employer is not required to provide these notifications in writing, but it observes that doing so would provide evidence that the employer has in fact given them.
 
No Limit On Pool Contributions
 
In the past, DOL's enforcement position was that an otherwise-valid tip-pool arrangement could not require employees to contribute a greater percentage of their tips than was "customary and reasonable".  DOL said that it would not question pool contributions of 15% or less of the employee's tips.

DOL now acknowledges that the FLSA "does not impose a maximum contribution percentage on valid mandatory tip pools".  However, DOL takes the position that an employer "must notify its employees of any required tip pool contribution amount .  .  .."
 
Time For A Check-Up
 
As with other areas affected by the Final Rule, employers can expect DOL investigators and plaintiff's lawyers to be scrutinizing tipped-employee pay practices even more than they already were.  Management should take a fresh look at where tipped-employee compensation stands.  This review should include not only DOL's recent changes, but also other potential FLSA tipped-employee issues, as well as any state or local requirements and limitations.

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