Tip pooling: What you need to know before diving in!
- Aaron Gallagher
- Feb 10, 2020
- 4 min read
Updated: Feb 12, 2020
Tips are a staple of the service industry. For entrepreneurs looking to open a restaurant, bar, hotel, or other service-based business, it is important to understand the role that tips may play in compensating employees. In this post, we will discuss what tips are, who can receive tips, what a tip pool is, the legal consequences of violating tipping laws, and how you as an entrepreneur can protect yourself.
WHAT ARE TIPS?
While it may seem obvious, we must have a clear definition of what tips are before we can discuss their legal implications. A tip is any money that is given to an employee by a customer that is in addition to the cost of the customer’s bill. Tips are the exclusive property of the employee and the employer/owner of the business has no right to that money. Tips can be paid in several different ways, including cash tips, tips paid by check, and credit card tips (however, this differs by state with some states allowing the employer to subtract the processing fees of the credit card from the employee’s tips). Service charges, such as those you might impose on a large party reservation, a private catering event, or for delivery are not tips and the employer is not required to give any of this money to the employee.
WHAT IS A TIPPED EMPLOYEE?
At first glance, this might also seem to be an obvious concept, but it is important to understand that there is a legal definition of a tipped employee. A tipped employee under 29 U.S.C.A. §203(t) is any employee who customarily receives at least $30 a month in tip income. The important word here is customarily. If your worker received a gift of over $30 from a customer or client on one occasion, but never received another tip, then they are not a tipped employee. Prior to 2018, the Fair Labor Standards Act mandated that employees who fell outside of the statutory definition could not receive tip income. However, in 2018 the Act was amended to allow employees such as cooks, janitors, and other non-customarily tipped employees to participate in tip pool distributions. The only condition to the inclusion of these employees is that the employer must ensure that all tipped employees are receiving at least the $7.25/hour minimum wage before sharing tips with non-tipped employees.
Employers are also allowed to claim a tax credit for tipped employees. For this credit, the minimum wage is treated as $5.15/hour. Any amount an employee makes per week exceeding that rate may be claimed by the employer as a tax credit at the end of the year. So tips aren’t just great for employees, they’re great for you too!
WHAT IS A TIP POOL?
While a business can elect to simply distribute tips to the workers who earn them, tip pools are another option. A tip pool is a system where employees pool their tip income together and agree to share it in equal amounts. This practice may work for a business that fluctuates between really busy and really slow days. This way, even employees who work slow shifts are able to make decent money.
Tip-sharing is another way to implement a tip pool. What makes tip-sharing different is that instead of an even split, employees have different percentage shares in the tip pool. This system can allow for a fairer distribution as employees can be compensated in accordance with their responsibility for the service to customers. Under this system, a bartender making drinks for customers will likely have a greater tip share than the host seating guests as their role is more directly involved in service.
Regardless of which strategy you may choose to pursue, it is important to note that the employer cannot participate in the tip pool. Remember that the employer has no right to the tip income of employees. This rule also prohibits any manager from participating in the pool.
WHAT ARE TIP POOL VIOLATIONS?
Common tipping pool violations include:
• Establishing a tip pool in a state that doesn’t allow it.
• Managers and leadership including themselves in the tip pool.
• Employers taking more of a tip credit than they’re entitled to.
• Employees not making the full minimum wage from the tip pool.
WHAT HAPPENS IF I VIOLATE THESE LAWS
The Fair Labor and Standards Act has steep consequences for any employer who violates tipping laws. Employers found in violation will be liable to their employee for the full amount of tips wrongfully withheld, any tip credit the employer may have taken on their tax returns, and liquidated damages. In addition, the Secretary of Labor may also impose a fine of $1,100 per violation.
HOW CAN I AVOID BREAKING TIPPING LAWS?
Luckily, there are plenty of ways for employers to practice good tip policies. Some examples are:
• Let your employees establish a tip pool. In most states, employee-run tip pools are usually okay.
• Treat tip pools as a recommendation that employees can opt in to as opposed to a mandatory pool.
• Ensure that all tipped employees receive at least minimum wage before allowing non-tipped employees to receive tips.
• Draft a written agreement regarding your tip pooling policy. Some states mandate this, but its good practice and a smart way to insulate oneself from liability.
• Be aware that no employer is obligated to pay an employee the difference of tips when a participant in the pool withholds their tips.
• Don’t encourage employees to contribute any amount to the pool and ensure that no participant is being pressured to contribute more than what is customary and reasonable.
• Clearly define service charges and tips for your employees to prevent misunderstandings.
If you’re curious to learn more about tip pooling laws and the tip tax credit that you as a service entrepreneur can collect, visit the Department of Labor’s website at:
At the time of this post, Aaron Gallagher is a 2L student at Penn State's Dickinson Law in Carlise, PA. He is interested in pursuing a career in tax or entrepreneurship law.
Sources:
29 U.S.C.A. §203
29 U.S.C.A. §216
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