Restaurants face special rules for payroll, wages and tips that set them apart from most other businesses. In few industries do customers directly help pay employee wages through tips. These rules come mainly from the federal Fair Labor Standards Act (FLSA) and state laws, and can lead to common compliance issues, if not handled carefully.
Minimum wage – While the federal minimum wage is $7.25 per hour, for tipped employees who engage in an occupation in which they customarily and regularly receive more than $30 per month in tips, their minimum wage is only $2.13 per hour in direct wages, as long as that amount, combined with the tips received, at least equals the federal minimum wage. Many states have a greater minimum wage, such as Florida, and also have a provision for a reduced minimum wage for tipped employees, where it is $14.00 per hour for regular employees and $10.98 per hour for tipped employees. The employee must earn at least $3.02 in tips per hour, otherwise the employer will need to pay the difference. Failure to do so will result in a FLSA minimum wage violation and can occur if tips are low or if employees don’t claim to the employer all of the cash tips they receive from the customer.
Overtime pay – This may be one of the most frequent violations found when it comes to tipped employees receiving less than the regular minimum wage. The Department of Labor’s Fair Labor Standards Act (FLSA) rule is 1.5 times their regular rate of pay for all hours worked over 40 in a seven-day continuous workweek. But when the hourly rate of pay is at the lower tipped minimum wage, that rule no longer applies and overtime is calculated on the regular minimum wage.
Using a Florida employer, as an example, whereby a tipped employee works 41 hours during the week,the employee would be owed 40 hours at $10.98 per hour, and the one hour of overtime is NOT at 1.5 times $10.98 ($16.47). Instead, the calculation takes the regular minimum wage of $14 per hour times half (0.5) which is $7.00 per hour. The $7.00 per hour is the overtime premium added to the tip minimum wage of $10.98 per hour to arrive at the overtime rate per hour of $17.98.
The formula is: (Tip minimum wage) + (Minimum wage X 0.5) = Tip overtime rate
Workers’ compensation – For the majority of businesses, workers’ compensation premium is incurred at a rate, based on the risk of injury for the classification of job the employee performs, times the wages the employee receives. For a restaurant, tips are excluded from those wages and hopefully, that is not a surprise for anyone. Note that a few states, such as Nevada, do not allow the exclusion of tips, so be sure to check your state laws.
There is a catch. For tips to be excluded from the premium calculation, they must be voluntarily left by the customer. Automatic gratuities and service charges are not excluded. Examples of the latter exclusions are an automatic gratuity that would be added to the bill of a wedding or banquet and the commonly-found practice at a restaurant of “an automatic 18% tip is added to parties of 6 or more.”
OBBBA Tips – We have already seen how tips can wreak havoc on reporting and compliance; the new One Big Beautiful Bill Act is no exception. In the case of the OBBBA, for tips to be classified as qualified tips eligible for the ‘no tax on tips’ deduction for an employee, they must be voluntarily left by the customer. Once again, we find that those automatic gratuities, as part of large banquets, are not qualified, and those automatic tips, added to a bill at some restaurants for large parties, are also not qualified.
FICA Tip Credit – Finally some good news, as it pertains to restaurants. Since 1993, there is a tax credit a business can take as a result of their paying taxes on the tips the employee receives directly from customers. Employers match the FICA taxes (Social Security and Medicare) an employee pays, and since an employee pays that tax on the amount of tips they received, the employer is paying taxes on an amount they did not pay to the employee. To offset this, the FICA Tip Credit exists. The calculation is based on the amount of voluntary tips left by the customer that exceed $5.15 per hour in wage paid to the employee. Gratuities and automatic tips are excluded from the credit. For states where the tipped minimum wage exceeds that amount, the calculation is simply the amount of tips times the FICA rate of 7.65%. If the hourly wage paid to the tipped employee is less than $5.15, then that amount is excluded from the credit calculation. For example, if an Alabama employee is paid $2.13 per hour and worked 30 hours and received $200 in tips, the calculation is $5.15 less $2.13, multiplying that by the 30 hours worked. The resulting amount is the portion of tips that are not eligible for the credit of $90.60. Total tips of $200.00 less $90.60 are the tips eligible for the credit, $109.40, which is multiplied by the FICA rate of 7.65%. A credit of $8.37. The credit adds up, as we have discovered that the typical credit is approximately $1,000 per tipped employee.
Final Thoughts
Automatic, non-voluntarily left by the customer tips have a number of cons that seem to outweigh the pros. Losing the tax credit to the employer, losing the taxable wage deduction to the employee, costing workers compensation premium, added to the fact that most restaurant point-of-sale systems are not capable of tracking voluntary tips left from the customer separate from involuntary tips, may very well outweigh the benefit of a guaranteed income to the employee, but that is a decision the restaurant owner needs to make knowing all of the facts.
Tips create both opportunities and pitfalls for restaurants. Staying compliant with wage rules, accurate tip tracking and understanding credits/deductions helps avoid penalties and supports better employee retention. Laws vary by state (and sometimes city,) so consult local regulations or a payroll expert, especially with changes like OBBBA. Proper systems for reporting voluntary versus automatic tips are more important than ever.
While we make every attempt to ensure the accuracy and reliability of the information provided in this article, the information is provided “as-is” without warranty of any kind. Romeo Chicco or PayMaster, Inc. does not accept any responsibility or liability for the accuracy, content, completeness, legality or reliability of the information contained. Consult with your CPA, Attorney, and/or HR Professional, as state and local laws and your situation may vary.
