• Employees receiving tips must be informed by their employer of any tip credit or tip pooling arrangements.
• The FLSA bans systems where any part of a worker’s tip is received by an employer.

Though they may be paid less than minimum wage, tipped employees must be informed (preferably in writing) of how the tip credit works, and they must retain all tips. Where tip-pooling is used, employers must be aware that individuals eligible to receive distributions from the pool will differ based on whether the tip credit provision is used.

Tipped employees are those who customarily and regularly receive more than $30 a month in tips. Tips received by these employees may be counted as wages under the Fair Labor Standards Act (FLSA) as a credit toward the minimum wage, but the employer must pay not less than $2.13 an hour in direct wages. If an employer elects to use the tip credit provision, that employer must:

1. Inform each tipped employee about the tip credit allowance (including amount to be credited) before the credit is used;
2. Be able to show that the employee receives at least the minimum wage when direct wages and the tip credit allowance are combined; and
3. Allow the tipped employee to retain all tips, whether or not the employer elects to take a tip credit for tips received, except when the employee participates in a valid tip pooling arrangement.

If an employee’s tips combined with the employer’s direct wages of at least $2.13 an hour do not equal the minimum hourly wage, the employer must make up the difference.

Note that some states (or municipalities) may have a higher minimum wage. Also, some states may not allow a tip credit at all, and instead require a full minimum wage for all employees — even if they receive tips. Other states may limit the amount of tip credit that can be taken to a certain percentage of minimum wage.

Employee requirements

Tips that employees receive from customers are generally subject to withholding. Employees are required to claim all tip income received. This includes tips the employer paid to the employee for charges to customers and tips the employee received directly from customers.

Employees must report tip income on the Internal Revenue Service (IRS) Form 4070, Employee’s Report of Tips to Employer, or on a similar statement. This report is due on the 10th day of the month after the month the tips are received. This statement must be signed by the employee and must show the following:

• The employee’s name, address, and Social Security number;
• The company’s name and address;
• The month or period the report covers; and
• The total tips received.

No report is required from an employee for months when tips are less than $20.

Employer requirements

In order to take a tip credit against the minimum wage obligation, employers must provide certain notices to employees. An employer is not eligible to take the tip credit unless it has informed tipped employees in advance of:

• The employer’s use of the tip credit;
• The amount of the cash wage that is to be paid to the tipped employee by the employer;
• The additional amount by which wages of the tipped employee are increased on account of the tip credit claimed, which may not exceed the value of tips received by the employee; and
• The fact that all tips received by the tipped employee must be retained by the employee except for a valid tip pooling arrangement.

The tip credit cannot by applied to any employee who has not been informed of these requirements.

Employers must collect income tax, employee Social Security tax, and employee Medicare tax on tips reported by employees. These taxes can be collected from an employee’s wages or from other funds that employee makes available.

Retention of tips

The FLSA forbids any arrangement between the employer and tipped employee whereby any part of the tip received becomes the property of the employer. A tip is the sole property of the tipped employee. Where an employer does not strictly observe tip credit provisions of the FLSA, no tip credit may be claimed and employees are entitled to receive the full cash minimum wage, in addition to retaining tips they may/should have received.

Service charges

A compulsory charge for service (e.g., 15 percent of the bill for large groups) is not a tip. Such charges are part of the employer’s gross receipts. Where service charges are imposed and the employee receives no tips, the employer must pay the entire minimum wage and overtime required by the FLSA.

A service charge differs from a tip because the customer does not decide whether to pay or how much to give. The payment is made to the employer, not the employee, and the employer could choose whether to pass the amount (or only a portion of it) along to the employee. Thus, even where a compulsory service charge is later given to the employee, it is part of the wages paid by the employer, not a tip received from the customer.

Since the service charge distribution is part of the wages paid by the employer, it counts toward the minimum wage obligation. It can also be counted toward the overtime rate.