The amount of work that a service worker puts into a job can make a real difference, and so can the way that they go about doing their job. A waiter who provides outstanding service turns a good meal into a great one. A cab driver who gets their passenger to their appointment on time despite traffic, the car wash attendant who works extra hard to get the dog hair out of the car’s upholstery — all of these people improve our quality of life, and as a result we reward them with what are known as tips.
Tips are an optional form of payment provided directly by customers and separate from wages paid by employers. Both federal and state tax laws have a host of regulations exclusively dedicated to how they are handled.
When a service employee receives a tip, state and federal laws ensure that the money they receive is theirs and theirs alone. They have been explicitly defined as a “gift or gratuity in recognition of some service performed” by the U.S. Department of Labor. Depending upon the individual establishment, some employees share or pool their tips with other employees: When all or part of tips received are collected by the employer to distribute among all tipped employees the arrangement is known as “tip pooling,” while “tip sharing” is a voluntary arrangement in which tipped employees such as servers will themselves tip the non-tipped employees, such as a busboy or service bartender, who assisted them. When employees are required to participate in tip pooling the process is regulated by the U.S. Department of Labor, while voluntary and informal tip sharing arrangements like tip sharing are not.
In some instances, a business will charge their customers a service charge directly on their bill. Though these charges may feel like tips to the client, they are not considered the same thing by the government. Rather than being the service employee’s property they are included in the employer’s gross receipts, and there is no obligation for the organization to distribute it or any part of it to the employee. Service charges are marked as such and are for a specific amount. They are not the same as the sample tip calculations that some restaurants include on a customer’s bill: Those are suggestions provided as a convenience, and the customer is under no obligation as to whether and how much an employee should be tipped.
While the main focus of the Fair Labor Standards Act (FLSA) is how employees are paid and the hours that they work, in addition to establishing rules about minimum wage, overtime and other related issues it also addresses tipping, and specifically as part of ensuring that those in the service industry are compensated to the standards of the federal minimum wage. It is the FLSA that establishes that an employer can’t keep an employee’s tips other than as permitted by law and that unless a valid tip pooling arrangement has been set up, employees are entitled to keep all of their tips.
The FLSA ensures that their tipped employees receive at least the $7.25 an hour mandated by the federal minimum wage by providing employers the opportunity to take a tip credit with which they can cover any difference between the $2.13 per hour that tipped employees must be paid and the minimum wage. Employers who take this $5.12 per hour credit are required to use it to make up any difference between the tips received and the minimum wage. Employers are not permitted to take a tip credit that is greater than the tips that the employee actually receives.
Some employers opt out of taking a tip credit, choosing instead to mandate a tip pool in which tipped employees must distribute tips to those who only work for wages. The line between what defines a tipped employee changes by the industry and job, but one characteristic offered by the FLSA is that they usually earn tips totaling more than $30 per month.
The rules surrounding tipping and tip pools were updated and the effective dates of some of them, were extended indefinitely by the Department of Labor on December 22, 2020, with the new regulations including the following:
Beyond federal regulations, individual states also have their own rules regarding tips and the state’s minimum wage. While states like Texas and Virginia set the minimum cash wage for tipped employees at the same $2.13 an hour as established by federal law, others like California have made the minimum wage for tipped employees the same as that for everybody else, with no consideration of tips received. Still others like New York and Massachusetts have sought a middle ground in which they are paid more than the federal $2.13 an hour amount.
Is there a difference between a tip and a “gratuity”?
The answer depends on the state’s laws. Texas’ Workforce Commission classifies a gratuity in the same way that it does a service charge, seeing it as part of the establishment’s gross receipts. Others, including the Department of Labor, view it as a tip. The determination depends on whether its payment is suggested or optional, or required as part of the customer’s bill.
What are the criteria for a “valid tip pooling arrangement”?
The term “valid tip pooling arrangement” refers to the explicit requirements under the FLSA, including:
Is there a resource for reviewing different states’ tipping laws?
Every state will have a web page associated with its labor office, and the information should be easily accessed by searching for the term “tips,”, “tip law,” or “tipping.” There is also a list of links to all state labor offices on the Department of Labor’s website.
Disclaimer: The information provided here does not constitute legal advice. For assistance in understanding and complying with tip regulations, seek the counsel of an attorney.
About Sonu Shukla, CPA, CFP
Sonu Shukla is a Certified Public Accountant as well as Certified Financial Planner. He believes in proactive tax planning and has the skills, education and experience to demonstrate passionately planned financial strategies. His firm tailors highly efficient tax plans for his small business clients, all in a one on one environment where he and the client can bounce ideas around until every detail is worked out. Located in Orlando, FL, he services all of Florida.
