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Review Your Tips Processes Now or Pay Later

Introduction

As of the DOL’s fiscal year ended September 31, 2022, the Wage and Hour Division of the Department of Labor (“DOL”) recovered over $27 million in back wages and illegally retained tips for more than 22,000 workers in the food service industry.[1] The reason? Employers improperly withheld and distributed tips that rightfully belonged to the employees, sometimes due to improper tip pools, sometimes due to failure to provide proper tip credit or tip pooling notices, and sometimes because of improper overtime calculations for tipped employees. Considering the DOL’s recent activity and focus on tips-related violations, we strongly encourage employers to refresh their understanding of the Fair Labor Standards Act’s (“FLSA”) and DOL tip regulations’ (the “DOL Tip Rule”) requirements regarding tips.

Read on for the first in a 3-part series providing an overview of important rules and regulations regarding the treatment and handling of “tips.” In this part, we review when a payment qualifies as a “tip” and why whether an employee is “tipped” vs “non-tipped” matters for employers taking a “tip credit.”

What is a Tip?

It is important to distinguish tips from other customer payments, such as service charges. A “tip” is any sum presented by a customer as a gift or gratuity in recognition of a service performed, as opposed to a payment for that service. For a payment to be a “tip,” the customer must have discretion over whether to pay and how much. If a customer is required to pay an amount, it is not a tip.

By contrast, a service charge is a compulsory amount – or “automatic gratuity” – applied to a customer’s bill. For example, a restaurant may automatically add a 15% gratuity to bills for tables of 7 or more customers. In this scenario, the gratuity is a service charge rather than a tip because customers have no discretion over whether to pay.

The DOL considers all facts and circumstances when determining whether an amount is a tip or service charge. However, for an amount to be a tip, “there must be evidence of actual discretion over the fact of and amount of the payment.” For example, the ability to leave a 15%, 20%, or 25% tip. In this scenario, while the customer gets to choose the amount applied, the gratuities are predetermined, so which bucket does the money fall under? When this occurs, the gratuity is considered a tip because the customer retains some discretion in the amount left in recognition of the service.[2]

Determining whether payments qualify as tips is important for several reasons, but two stand out. First, only tips may qualify someone as a “tipped employee” and be credited toward the tipped-employee’s minimum hourly wage through the “tip credit.” Second, tips belong to the employee, and employers are strictly limited as to what they may do with employees’ tips.

The Tip Credit and Minimum Wage

Like all other non-exempt employees, tipped employees must receive the minimum hourly wage for each hour worked. However, the “tip credit” allows employers of “tipped employees” to credit a certain amount that each tipped employee receives in tips toward the employer’s hourly minimum wage obligation. In other words, employers may pay a lower hourly wage to tipped employees because those employees are receiving tips.

As of January 1, 2023, the minimum wage in Michigan is $10.10. Michigan requires employers to pay tipped employees an hourly wage of at least 38% of the minimum wage, which is currently $3.85.[3] This means employers may take a “tip credit” of up to $6.25 per hour toward their minimum wage obligations with respect to their tipped employees. However, employers must keep in mind several critical caveats to taking the tip credit.

Only Take the Tip Credit For “Tipped Employees”

For employers looking to take the tip credit, the credit may only be applied to tipped employees. A “tipped employee” is any employee engaged in an occupation in which the employee customarily and regularly receives more than $30 a month in tips.[4] An employee who sporadically or occasionally receives tips totaling more than $30 a month, such as on Christmas or New Years, is not considered a tipped employee.[5] For example, “tipped employees” include servers, bellhops, counter personnel who serve customers, bussers, bartenders, barbers, and hairdressers. Whereas, positions like dishwashers, cooks, chefs, salad preparers, and janitors do not customarily and regularly receive tips from customers, and so would not qualify as “tipped employees.”

            Do Not Take a Tip Credit that Exceeds the Amount of Tips Actually Received by the Employee

While the lower hourly wage is sometimes referred to as the “tipped minimum wage,” this phrasing can be misleading. Employers taking the tip credit must still ensure that their tipped employees take home at least the minimum wage. Employers may only take the tip credit up to, and not exceeding, the amount of tips actually received by the employee: if a tipped employee’s hourly rate of pay, including their tips, is less than $10.10 per hour, the employer must compensate the employee the difference.

Example:

Linda receives $40 in tips in an 8-hour shift. Her employer takes the tip credit, so she is paid $3.85 per hour. That means her employer will pay her $30.80 and she received $40 in tips, making a total of $70.80 for the shift.

That’s $8.85/hr for that shift, which is below Michigan’s $10.10/hr minimum wage. Linda’s employer must pay her an additional $10 to get her to at least minimum wage ($10.10 x 8) for that time.

Reminder: the minimum wage – and therefore the “tipped minimum wage” – in Michigan will continue to annually increase over the next few years. Employers should habitually (at least annually) re-assess the minimum cash wage for tipped employees applicable to their business.

Provide Notice to Employees

Before taking the tip credit, employers must inform tipped employees of their intent to take the tip credit. The FLSA requires this notice to substantively include the following statements:

  • The cash wage amount paid to the tipped employee (in Michigan, no less than $3.85 per hour);
  • The additional amount claimed by the employer as a credit (in Michigan, no more than $6.25 per hour);
  • The tip credit taken by the employer may not exceed the value of the tips the employee actually receives; and
  • All tips received by the tipped employee must be retained by the employee unless the employer uses a tip pool;

Employers may not take the tip credit for any tipped employee who has not received the notice. It is therefore important to obtain each newly-hired tipped employee’s signed acknowledgment that they have received and understand the employer’s tip policy as a routine step in the onboarding process and to regularly update the notice when the minimum wage changes.

What are Employers Allowed to Do With Tips?

All tips belong to the employees. Employers can only keep tips for one of the following specific purposes:

  • Redistributing under a valid tip pool (discussed below); or
  • Paying with credit card processing/service fees attributable to credit card tips.

Employers may legally use a fraction of employees’ credit card tips to pay credit card processing fees associated with those tips. For example, credit card companies commonly charge restaurants processing fees of, say, 3% of a bill run on their card. Under this scenario, employers may retain 3% of the tip paid on that credit card to pay the portion of the processing fee allocable to the tip. However, the remaining 97% must be remitted back to the employee since, again, the tip is the employee’s sole property. Retaining any amount of the tip in excess of the 3% would violate FLSA.

Further, employers cannot offset credit card fees if doing so would reduce the employee’s hourly wage to below the minimum wage.

Remember: managers and supervisors are considered extensions of the employer, and therefore, cannot retain tips, regardless of whether the employer takes the tip credit.[6] The only exception to this rule is when tips are given directly to managers for work performed by the manager.[7] Despite the restriction on benefiting from the tip pool, employers can require managers to contribute to the tip pool.[8]

Under Michigan law, employers are required to maintain itemized records of employees’ wages, hours worked, and tips made.[9] Additionally, employers must retain these records for at least 3 years.[10]

Key Things to Remember:

  • Did the customer have a choice in leaving a payment or determining the amount? If yes, it is likely a tip and is the employee’s property. If the customer had no choice whether to leave the payment or determine the amount, it is a service fee and the employer’s property.
  • Employers should re-evaluate minimum wage payment to tipped employees at least annually as the minimum wage in Michigan is increasing at that same time interval.

By Mitchell Zolton and Kaitlyn Harries

This publication is intended for educational purposes only. This communication highlights specific areas of law and is not legal advice. The reader should consult an attorney to determine how the information applies to any specific situation.

[1] https://www.dol.gov/newsroom/releases/whd/whd20230614-1

[2] DOL, “Field Operations Handbook,” Chapter 30d17; IRS Rev. Rul. 2012-18; IRS Pub. 531

[3] MCL 408.934(1); MCL 408.934d

[4] 29 CFR 531.57

[5] Id.

[6] 29 CFR 531.52(b)(2)

[7] Id.

[8] 86 FR 52973(V)(D)

[9] Mich. Admin. Code R 408.702(1)

[10] Mich. Admin. Code R 408.702(4)

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