The Tip Credit, part of the Fair Labor Standards Act, is a pay rule that applies to the required federal, state and city minimum wage rates for people working in the restaurant and hospitality industries.
Employees in restaurants, bars and other industries where employees often are tipped by customers receive a substantial portion, if not the majority, of their compensation from those tips. In this case, the federal government and many states have established a separate minimum wage for tipped employees that is less than for employees who work in businesses where tipping is not customary. Under federal law, a waitress or bartender is permitted to be paid less by his or her employer than, a retail store sales clerk for example, given the business reality that tipping by customers makes up a large part of such employee’s compensation.
Tip Credit essentially lets employers pay their workers less than the legal minimum wage because it is assumed that the tips they receive will more than make up the difference. The portion of compensation that the restaurant is required to pay is referred to as the “cash wage minimum.” The difference between the cash wage and the regularly mandated minimum wage is “The Tip Credit.”
While Tip Credit means that employers can pay a lower cash wage, they still must ensure that employees do in fact receive the federally, state and locally mandated minimum wage. That is why it’s critical that employers are careful to ensure that not only are they in compliance with federal minimum wage laws, but that they are in compliance with any applicable state and local laws, including taxes, that apply as well. We’ll get into that later in this article. First, it’s important to understand who’s eligible.
Who Is a Tipped Employee Eligible for the Tip Credit?
For purposes of federal law, tipped employees as defined as those who customarily and regularly receive more than $30 per month in tips. However, state, federal and local law also define who is considered a tipped employee for purposes of the tip credit.
In the restaurant industry, the easy way to divide tipped vs. non-tipped employees is front of the house (servers, bartenders, or bus-boys) vs. back of the house employees (cooks or dishwashers). Front of the house employees are typically tipped, whereas back of the house employees are not. Any employer is able to apply the tip credit to pay wait staff or bartenders with the lower minimum wage for tipped employees, but not cooks or dishwashers. Employers are responsible for paying back of the house employees the full non-tipped minimum wage that applies where that employer is located.
Location, Location, Location: The Old Adage Applies to The Tip Credit, too!
Employers have to be proactive to ensure that, not only are they in compliance with all federal minimum wage requirements for tipped employees, but also in compliance with state and local laws, which can differ. Many states and local governments have different minimum wage requirements and therefore have set the tip credit at a different rate. The end result impacts the exact wages to be paid out.
It’s important to note that some states do not offer any Tip Credit at all and that employers in those states must pay the full wage.
Let’s take New York as an example because its minimum wage tip credit laws operate similarly to federal law in allowing a tip credit to employers in certain industries. Recent increases in the minimum wage in both New York State and New York City have raised the minimum wage for both tipped and non-tipped employees. But, the federal minimum wage has not been raised, which can be a source of confusion for many restaurant owners and operators.
Today, the federal minimum wage is $7.25. For tipped employees it sits at $2.13 per hour because there is a permissible maximum tip credit for employers of $5.12.
New York City:
Non-tipped employees: $15 minimum wage per hour
Tipped employees: $10 minimum wage per hour with a permissible tip credit of $5 per hour.
Downstate counties (Nassau, Suffolk, and Westchester):
Non-tipped employees: $13 minimum wage per hour
Tipped employee: $8.65 minimum wage per hour with a maximum tip credit of $4.35 per hour
The rest of New York State outside New York City and these downstate counties:
Non-tipped employees: $11.80 minimum wage per hour
A tipped employee: $7.85 minimum wage per hour with a maximum tip credit of $3.95 per hour.
What Businesses Qualify to Use the Tip Credit When Paying Their Employees?
The Internal Revenue Service (IRS) is strict about which businesses are eligible for the federal version of the tip credit. A business must meet both of the following two criteria in order to be eligible:
Its employees must receive tips from customers for providing, delivering, or serving food or beverages for consumption.
The business owner or operator must have paid the employer side Social Security and Medicare (commonly known as FICA) taxes on the tips the tipped employees earned.
A business where employees may occasionally receive tips, but do not do so regularly (such as a bagger at a grocery store) would not qualify for the tip credit. That grocery store owner and operator would instead be responsible for paying the full, non-tipped minimum wage for the bagger in this example.
Important Note: For restaurants, the owner or operator also needs to ensure that, even if he is only paying the lower tipped minimum wage, they still need to pay the required FICA taxes on the tips the employee is receiving. Otherwise, the business would not qualify to enjoy the benefits of the tip credit under federal law because it would be failing the second prong of the IRS criteria for utilizing the tip credit.
What Are Common Problems That Arise Related to the Tip Credit? Are There Any Penalties for Non-Compliance?
The short answer is yes. It’s imperative that you follow the letter of the law to avoid penalties.
Let’s dive into it:
Tax and pay laws are complicated, so it’s really no surprise that the laws regulating the tip credit are not well understood by a lot of restaurant operators. However, a lack of understanding doesn’t mean you won’t be penalized if you violate the requirements.
Tip #1: Make sure your employees make enough tips to exceed the mandated minimum wage
It is the employer’s responsibility to ensure that all workers make at least the minimum wage. So in the event that an employee does not receive enough tips in a particular pay period to make up the difference between the direct (or cash) wage payment from the employer and the federally mandated minimum wage, the employer must make up the difference.
Because a restaurant wants every front-of-house employee to earn enough tips (so that they do not have to shell out more than the cash wage minimum), many are investing in systems and tools that empower their employees be happier and more effective in their jobs. For example, some restaurant reservation software provides detailed information on guests preferences and dietary concerns. This data helps wait staff personalize their recommendations and ensure they are providing the highest level of service possible.
Tip #2: Make sure you pay all the taxes
Another mistake businesses that take the tip credit can make is to not pay the employer side FICA taxes on the tipped employees’ earnings that actually come from tips. This is one of the requirements for utilizing the tip credit, so it is essential to ensure that if you own or operate a restaurant and take the tip credit, then you are in compliance with this requirement. Simply put, you are responsible for paying the taxes on the total compensation that an employee receives, including the portion you pay in cash, and the portion they receive in tips.
Employers must be very careful to ensure they are compliant with the applicable minimum wage laws because it is the employer, not the employee, that will be penalized if an employee does not receive the federally mandated minimum wage. Such penalties can include sizeable fines. It’s also very important to keep in mind that laws, especially tax laws can change, so take care to stay up to date on the regulations in your state.