In the restaurant business, using the “tip credit” method of paying employees under the Fair Labor Standards Act (“FLSA”) is analogous to a kitchen worker chopping vegetables with an extremely sharp chef’s knife. If handled properly, it’s an extremely useful tool for restaurants to manage high up-front labor costs. If handled carelessly, it can result in expensive litigation and high-dollar liability.
A national steakhouse chain recently agreed to pay $995,000 as part of a settlement to resolve claims it failed to properly pay servers and other employees who received tips. For smaller businesses with less resources, mistakes with tip credit can result in catastrophic liability. Likewise, the continued use of tip credit by the restaurant industry and other hospitality businesses is under attack by the current U.S. Department of Labor.
The Basics
In most instances, employers are required to pay nonexempt workers at least the minimum wage of $7.25 per hour. However, the FLSA allows an employer to satisfy a portion of its minimum wage obligation to a “tipped employee” by taking a partial credit, known as a “tip credit,” toward the minimum wage based on the amount of tips an employee receives. 29 U.S.C. 203(m)(2)(A). This allows paying a subminimum wage, as low as $2.13 per hour, provided that the employer makes up the difference with tips earned by and paid to the employee. Under the FLSA a “tipped employee” is defined as “any employee engaged in an occupation in which he customarily and regularly receives more than $30 a month in tips.”
Compliance with tip credit can be complex and mistakes are common. Failure to abide by the extremely strict rules can invalidate the employer’s entitlement to the tip credit and make the restaurant liable for unpaid wage claims, liquidated damages and attorneys’ fees. The basic requirements for restaurants to use the tip credit include:
• The employer must notify workers in advance that: (a) the employer intends to utilize the tip credit and treat tips as satisfying part of the employer’s minimum wage obligations and (b) if the amount of tips plus hourly wages does not match or exceed the applicable minimum wage, the employer must make up the difference. The FLSA does not require this notice to be in writing, but it is a best practice to do so and have the employee agree by signing a form.
• Tipped employees must retain all tips earned by that employee. The restaurant or managers cannot receive any portion of the tips.
• Only employees who customarily receive tips, such as servers, may be paid utilizing the tip credit. Typically, back-of-house workers, such as cooks and dishwashers, cannot be paid using the tip credit.
• The exception to restaurant employees retaining all tips is if there is a valid tip pooling arrangement where all tips are combined and shared among all tipped employees according to a pre-determined formula. A tip pool will be considered invalid if non-eligible workers or managers are allowed to participate.
Hostility to Tip Credit from the U.S. Department of Labor
Compliance with the tip credit has recently become even more problematic. The Biden Administration’s DOL has reinstated the so-called “80/20” rule. Under the reinstated policy, when tipped employees spend at least 20% of their workweek performing duties that support their occupation but do not directly produce tips, their employers are required to pay them a direct cash wage of at least $7.25/hour for that work, instead of a direct cash wage of $2.13/hour, with the remainder made up by tips. Examples of work that is not tip producing might include a server preparing food for a salad bar or cleaning the kitchen or bathroom or a bartender cleaning the dining room.
The current DOL has made clear its hostility to the tip credit method of payment and its intent to discourage its use, as well as its intent to vigorously investigate any allegations of noncompliance. For this reason, restaurants should make sure they are meeting all of the requirements and potentially consult with counsel on alternative payment methods.
Mandatory Service Charge v. Tip Credit?
A recent decision by the U.S. Court of Appeals for the Eleventh Circuit illustrates how some restaurants may be moving away from using the tip credit method versus a mandatory customer service charge that would go toward paying employee wages and potentially avoid the headaches of tip credit.
In Compere v. Nusret Miami, an upscale Miami steakhouse added a mandatory 18% "service charge" to customers' bills. It directly collected these payments and redistributed them to certain employees on a pro rata basis to cover the restaurant’s minimum and overtime wage obligations. Unlike tips, the service charge payments never went directly to the wait staff. Employees sued the restaurant, claiming the service charge was in fact, actually a tip.
The Eleventh Circuit ruled in the restaurant’s favor, finding that because it was a mandatory charge, unaffected by the customer’s discretion. However, using this method also carries its own complicated requirements and wage issues, and while common in other countries, American restaurant customers do not generally favor mandatory service charges.
Please contact Mark Fijman if you have questions or need compliance advice or guidance as to labor and employment issues in the restaurant or hospitality industry.
