Employees in many service businesses, including servers in restaurants, bartenders, cab drivers, car wash workers and many others, receive tips from customers regularly. Tip income is the property of employees, and both federal and state tipping laws and regulations are set up to protect that income.
Tip Pooling vs. Tip Sharing vs. Service Charges
Tips are optional payments by customers to employees in certain types of jobs. The U.S. Department of Labor defines tips as sums presented by a customer as a “gift or gratuity in recognition of some service performed.”
Often tips are distributed in different ways by employees—tip pooling and sharing—or are included in customer bills.
Tip pooling and tip sharing are similar processes for accumulating tips between employees. Tip pooling is collecting all or part of the tips received by employees into a pool, which is then redistributed, often by the employer, among tipped employees. Tip sharing, on the other hand, is a more informal voluntary process among employees, both those who usually receive tips and those who don’t.
The U.S. Department of Labor regulates tip pooling arrangements, but not tip sharing.
Employers that don’t take a tip credit can operate a mandatory tip pool that includes employees who typically work only for wages, like dishwashers and bussers.
Service charges are different from tips. They are required amounts that a business charges customers, usually stated directly on the customer’s bill. For example, some restaurants include a service charge for large groups. They are considered part of the employer’s gross receipts, and it’s up to the employer if employees receive part of the service charge.
Some restaurants include sample calculations of tip amounts on the customer’s bill, with the actual tip line left blank. The IRS says these sample calculations are not service charges, because the customer determines the amount of the tip (or leaves the amount blank).
Federal Laws and Regulations
The main federal law relating to tipped employees is the Fair Labor Standards Act (FLSA). This law is concerned primarily with employee wages (pay) and work hours, and it establishes minimum wage, overtime, and other standards. The FLSA considers tips as part of its mandate to make sure every employee receives at least the minimum federal minimum wage.
The FLSA and Tipping
The FLSA makes it clear that tips are considered property of the employee, and an employer may not use an employee’s tips for any reason other than as permitted by law. Employees have a right to keep all of their tips, unless there is a valid tip pooling arrangement in place, with only employees who customarily and regularly receive tips taking part.
Employers may take a tip credit toward their obligation to pay employees the federal minimum wage (currently $7.25 an hour). Here’s how this works:
- An employer must pay employees at least $2.13 as wages.
- The employer can then take a tip credit of up to $5.12 an hour ($7.25 – $2.13 = $5.12).
- The tip credit can’t be more than the tips actually received by the employee.
- If the employee’s tips are less than $5.12 an hour, the employer must make up the difference.
The FLSA says a tipped employee is someone who usually earns more than $30 per month in tips. The definition of “tipped employee” varies by occupation, and it may vary by state.
New DOL Regulations for Tipping and Tip Pools
On December 22, 2020, the Department of Labor announced a final rule revising its tipped employee regulations. Here are some of the significant details:
- Employers, including managers and supervisors, are not allowed for any reason to keep tips received by employees, even if they take a tip credit.
- Employers that collect tips for a tip pool must fully redistribute tips no less often than when it pays wages.
- There is a new recordkeeping requirement for employers that don’t take a tip credit but collect employee tips as part of a mandatory tip pool.
- An employer may take a tip credit for the time that an employee in a tipped occupation (a restaurant server, for example) does non-tipped duties (like cleaning).
- An employer that doesn’t take a tip credit may set up a mandatory tip pool that includes employees who don’t customarily and regularly receive tips.
State Laws and Regulations for Tipping
All states also have laws regulating tips, with varying rules for whether they include tips or the tipped amount is included in the state’s minimum wage. Some states, such as California, require employers to pay tipped employees the full amount of the state minimum wage before taking tips into account.
Other states, including New York and Massachusetts, require employers to pay tipped employees a higher minimum cash wage than required under the federal law ($2.13 an hour).
And one other group of states primarily located in the South, such as Texas and Virginia, have a minimum cash wage equal to the amount required under federal law ($2.13 an hour).
Tip Pooling Laws – FAQs
Is a gratuity a tip?
The term “gratuity” can mean several things. The DOL defines it as a tip, but the Texas Workforce Commission says a gratuity is more like a service charge, added by the business to a customer’s bill for services rendered. The definition hinges on the nature of the gratuity. If it’s a mandatory inclusion in a customer’s bill, as in, “15% gratuity for groups over 10 people,” it’s a service charge, not a tip.
What is a “valid tip pooling arrangement”?
To be a valid tip pooling arrangement for the purposes of receiving the tip credits, the following criteria must be met:
- The employer must show that the payment of wages and tips is equal to or greater than the federal minimum wage.
- The employer must inform employees of the tip pooling policy.
- Owners, managers, and employers can’t participate in tip pools.
- Only tipped employees can be in the pool.
Where can I get information about my state’s tip laws?
The Department of Labor has a list of state labor offices. Search your state’s labor office website for “tipping,” “tip law,” or “tips.”
Disclaimer: Tipping regulations are complicated and federal and state laws change. This information is a general overview, not detailed tax or legal advice. Get help from an attorney to make sure you are complying with the laws.