Tipped Employees
Posted on November 30, 2011
Payroll can be a unique challenge for businesses that employ tipped workers. Complex regulations that change from federal to state and local levels make handling payroll for tipped employees a complicated undertaking for many small businesses. By understanding government regulations concerning tipped employees, employers can take appropriate steps to reduce risk and ensure compliance.
Minimum Wage for Tipped Employees
Federal law determines the minimum wage rate at which employees can be paid. Although individual states set their own minimum wage rate, unless the state rate is higher, employers must pay their employees based on the federal minimum wage. This is true for tipped employees as well.
As of July 24, 2009, the federal minimum wage rate is set at $7.25 per hour. However, federal law also allows employers to count employee tips as part of their wages by taking a credit against the minimum wage requirement. The maximum amount of credit that the employer can apply is $5.12 per hour resulting in a tipped employee federal minimum wage of $2.13 per hour when the maximum credit is applied. This credit applies only to tipped employees, and many states have regulations concerning these credits. The Wage and Hour Division of the U.S. Department of Labor (DOL) maintains a table of minimum hourly wages for tipped employees, segmented by state, on their website.
Although employers can take advantage of the tip credit, it is still the employer’s obligation to ensure that, when wages and tips are combined, the employee rate of pay is meeting or exceeding the equivalent of minimum wage. In states where the minimum wage is higher than $7.25, employers must be sure employees are receiving the equivalent of the state minimum. If an employee’s tips do not bring the total up to minimum wage, the employer must pay the difference to the employee. A list of state minimum wage rates can be found on the DOL website.
Overtime for Tipped Employees
In a state that allows the employer to take the full $5.12 tip credit, there is a special overtime rule. For any overtime hours worked the maximum tip credit is still only $5.12. In other words, the employer cannot calculate the employee’s overtime rate as $2.13 x 1.5, or $3.19. Instead, the overtime rate should be calculated as indicated below:
$ 7.250 minimum wage
3.625 plus 1/2 minimum wage
$10.875 hourly overtime rate
-5.120 less tip credit
$ 5.755 overtime rate for tipped employees being paid federal minimum wage
If an employee’s hourly rate is higher than minimum wage, the overtime rate is time and one-half the hourly rate actually paid.
Pooled Tips
In some establishments, employees who regularly and customarily receive tips are required to contribute a portion of their tips to a pool, which is then divided among a group of employees. Employees may only contribute any amount in tips received that are in excess of minimum wage when combined with their hourly wage. Tips from a pool cannot go to employees, like chefs and dishwashers, who don’t usually receive tips. Employers, and in some states managers or supervisors, are prohibited from receiving funds from pooled tips.
Reporting Tips
Employees receiving more than $20.00 per month in tips must report the total amount of their tips to the employer by the 10th day of the following month. The IRS provides Form 4070, Employee’s Report of Tips to Employer, for this purpose, although employees may use anything similar to complete this reporting. The report must include the employee’s name, address, Social Security number, employer’s name and address, the period that the report covers and the total tips received.
Tips reported must include both amounts received directly by the employee and charged tips paid over to the employee. Generally, employees report their tips to their employer at the end of each night on paper or through the restaurant management software.
Additional information about tip withholding and reporting, including W-2s, tip allocation and voluntary compliance programs is located on the IRS website.
Legislative Update:
Effective May 5, 2011, a tip credit regulation under the Fair Labor Standards Act requires employers to provide oral or written notice to each employee that the employer is taking the tip credit and how the employee’s tips will be applied to their wages. Notification must include the following:
- The hourly rate the employer is paying the tipped employee (at least $2.13/hour)
- The amount the employer is claiming as a tip credit (not more than $5.12/hour)
- The tip credit cannot exceed the actual tips received by the employee
- All tips received by the tipped employee remain the property of the tipped employee (except in a valid pooling arrangement).
- The tip credit will not be applied to any employees’ wages unless the employee has been notified of the tip credit provisions.
If an employer fails to notify the worker, use of the tip credit is prohibited and the employer must pay the employee at least minimum wage and allow the employee to retain all tips. Should the employer not inform the employee and take the tip credit, the business is subject to criminal and civil penalties from the U.S. Department of Labor in addition to any lawsuit the employee may file.
The DOL has issued a fact sheet titled Tipped Employees Under the Fair Labor Standards Act (FLSA) that is available for download from their website. The fact sheet covers the application of the FLSA laws to tipped employees, including wage rates, tips and pooling, service charges, dual jobs and gives examples of typical issues employers and employees may encounter when handling tip income.
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The material contained in this document is for informational purposes only and is current as of the date of publication. CompuPay is not a legal advisor or financial advisor and makes no claims as such. For financial or legal advice, please seek the advice of a professional.
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