Restaurant Basics: What is the Tip Credit?

Restaurant owners are constantly making costly decisions involving their business and employees. With the Department of Labor’s recent decision to  abandon the 80/20 Rule, we thought it may be helpful to bring it back to basics and break down the pros and cons of employers taking a tip credit from their employees.

What is a tip credit?

The Fair Labor Standards Act (FLSA) allows employers to take a tip credit from their minimum wage obligation for tipped employees equal to the difference between the required cash wage and the federal minimum wage. Currently, the maximum tip credit under Federal Law equates to $5.12 per hour. The minimum cash wage the employer can then pay their tipped employee is $2.13 per hour.

Please note, there are many state and local requirements that differ from the above Federal requirements. Some states do not allow an employer to take a tip credit at all. Reach out to your HR Consultant if you have any questions regarding these amounts.

When can a tip credit be taken?

Legally, employers can only take a tip credit if they are properly communicating the amount of the cash wage the employer will pay the tipped employees, along with the tip credit amount the employer is taking from the minimum wage obligation. Additionally, all tips received by the tipped employee are to be retained by the employee, except in situations where a valid tip pool arrangement is in place.

Remember, the tip credit is only allowed when employees are making at least the required minimum wage in tips. If an employee does not make enough in tips that pay period, the employer will need to pay the difference, ensuring they are paid the minimum wage. This is often times referred to as “make up to minimum”.

Who are tipped employees?

The FLSA defines a tipped employee as someone who customarily and regularly receives at least $30 in tips per month from paying customers. Most commonly, these employees are servers, bussers, runners, and/or bartenders.

Remember, managers and supervisors are never eligible for tip pools!

How is the overtime rate calculated with a tip credit?

Calculating a tipped employee’s overtime rate is often done incorrectly due to misinterpretation of the overtime calculation. It is important to understand and clarify the accurate way to calculate this overtime rate when employers are taking a tip credit from the minimum wage obligation.

To keep it simple, overtime is calculated on the full minimum wage, and not the cash wage payment. Here’s the calculation:

(State or Federal Minimum Wage x 1.5) – Applied Tip Credit = Overtime Hourly Rate

And here’s a worked example using the federal minimum wage:

($7.25 x 1.5) = $10.88 – $5.12 = $5.76/hour, which is the compliant overtime hourly rate for a tipped employee.

As you can see, this can be quite time consuming to do manually. For restaurant clients using StratEx’s payroll, no need to worry, our system can automate this calculation compliantly, and save you the hassle.

What is the 80/20 Rule anyway?

Previously, courts would look into the amount of time employees spent completing non-tipped duties to determine if an employer is eligible to utilize a tip credit. These duties include clearing and cleaning tables, rolling silverware, preparing salads, and sweeping floors. If that time exceeded 20% of an employee’s workweek, the employer would NOT be able to take a tip credit and the employee would be eligible for the full minimum wage. Given the recent guidance from the Wage and Hour Division, as highlighted above, employers no longer have to worry about adhering to the 80/20 Rule. Restaurants can rest assured they are in compliance when taking a tip credit from an eligible tipped employee, as long as said employee is performing tasks and duties related to the tipped occupation (regardless of whether those tasks are directly related to serving guests).

The Pro’s & Con’s of a tip credit

Employers can reap financial benefits when they legally administer a tip credit. Not only are employers able to lower their payroll costs, but also their Medicare and Social Security payroll taxes may be lowered, leaving restaurant owners with more money in their bottom line.

According to new government data, reported by Restaurant Business Online in October of 2018, the restaurant industry is facing a shortage of labor and has lost 18,200 jobs. Additionally, with a record low unemployment rate, employees have more negotiating power and leverage to seek out employers who are willing to pay above the minimum wage. Restaurants who are looking for a competitive advantage may consider paying closer to or above the minimum wage and decide against taking a tip credit, to help increase their talent pool in such a tight labor market.

Adding to my colleague, Krystal Hentges’s, recent blog post regarding engaging back-of-house employees, it may be beneficial for restaurants to consider including their kitchen staff in a tip pool to boost engagement and productivity. As a result of a Field Assistance Bulletin published in 2018,employers are permitted to include traditionally non-tipped employees (like cooks and dishwashers) in a tip pooling arrangement provided employers are not taking a tip credit, and are paying the full minimum wage to all employees. As a reminder, under no circumstances can managers or supervisor be included in a tip pooling/tip sharing arrangement.

If your restaurant has a tip pooling arrangement in place, the best practice is to have your StratEx HR Consultant review this policy to ensure the validity and compliance with local, state, and federal law. Not only is having a clearly defined policy important, but also having all eligible participants acknowledge their understanding of such policy is a key factor for compliance. Please keep in mind, some states prohibit tip pooling with back-of-house employees and further place restrictions on tip pooling policies.

Ultimately, restaurant employers should consider these factors, in addition to the administrative burdens, when evaluating whether it makes sense to take a tip credit from those eligible tipped employees.

It is important that restaurants are aware that taking a tip credit can pose risk under the Fair Labor Standards Act and they should consult their Human Resources department and/or reach out to their designated StratEx HR Consultant for guidance on compliance!