By Michelle Anderson, Attorney, Fisher & Phillips, LLP (New Orleans)
The following article generally discusses tipped employee rules that an employer may adopt for employees. The article is not intended as legal or tax advice, and any specific question regarding a particular policy or rule for your workplace should be addressed with legal counsel to ensure compliance with all applicable federal and state laws.
The simple act of tipping has become a hot bed of legal concern for the restaurant and hospitality industries. As the Department of Labor’s enforcement efforts continue to grow and private wage and hour lawsuits increase, these industries are prime targets for tipped employee violations. To further complicate matters, effective January 2014, the IRS implemented new guidelines for tips and service charges. While customer generosity should be encouraged, businesses in these industries need to ensure compliance with applicable laws.
The Ground Rules:
All non-exempt employees must be paid the minimum wage under federal and state law. Under the federal Fair Labor Standards Act (FLSA), tipped employees are those who regularly receive more than $30 per month in tips. The tip credit provisions of the FLSA permit an employer to pay tipped employees no less than $2.13 per hour in cash wages and take a “tip credit” equal to the difference between the cash wages paid and the federal minimum wage. The tip credit may not exceed the amount of tips actually received and, under the current minimum wage, may not exceed $5.12 per hour. For example, under federal law, an employer can pay a tipped employee $2.13 per hour and take a “tip credit” of $5.12 per hour, provided the tipped employee makes sufficient tips to cover the tip credit. If the employee does not earn sufficient tips for the tip credit, the employer must make up the difference to ensure the employee receives minimum wage for all hours worked. Employers must keep clear records to demonstrate proper application of the tip credit.
The use of tip credit can also be complicated by state laws. Some states forbid the use of tip credit, while others impose significant record-keeping and/or notice requirements on the use of tip credit. Louisiana currently follows the federal law, which requires that employees be notified in advance if the employer will take a tip credit. Written notice is recommended.
Some employers might be tempted to not require employees to report tips under $30 per month, or report tips beyond what brings them up to the amount of the tip credit taken. Both of these practices are flawed and could create tax liability.
The definition of a tipped employee for purposes of IRS reporting differs from the FLSA. The IRS defines a tipped employee as one who earns $20 or more per month in tips. Employees are required to report to their employer the total amount of tips they receive. Employees must provide the employer with written reports by the tenth of the following month. Employees who receive tips of less than $20 in a calendar month are not required to report their tips to their employer, but must report these amounts as income on their tax returns and pay necessary taxes.
Therefore, even if an employee is not deemed a “tipped employee” under the FLSA, per the IRS the individual may still be considered a “tipped employee” for purposes of reporting the income generated by tips. Hence, the best practice is to simply require employees to report all tips.
Tips, Service Charges, and Wages:
You may be asking yourself: “What is all of the confusion about? Everyone knows what a tip or a service charge is.” Surprisingly, it is not that straight forward.
A tip is made by the customer free from compulsion. The customer has an unrestricted right to determine the amount; the payment is not subject to negotiation or dictated by the employer; and the customer generally has the right to determine who receives the payment. Tips include all cash given to the employee, whether directly from a customer or a tip pool, as well as tips charged on credit or debit cards. Employers must withhold payroll taxes from the tip amount reported (i.e. Medicare, social security and income taxes).
A service charge is a compulsory fee. For example, adding 15 percent to the bill for a table of eight or more people. Service charges are generally considered part of the business’s gross receipts. Businesses may pay wages from these service charges, but cannot under any circumstance take a tip credit using a service charge. While service charges are not tips, they can be wages.
A service charge can be considered wages if any portion of the service charge is given directly to the employee in addition to their hourly wage. Hence, if a restaurant charges a 15 percent gratuity (service charge) to a party of eight or more and gives the server 5 percent of that fee, that must be reported as income to the IRS and factored into the regular hourly rate for the week for purposes of calculating overtime under the FLSA.
For example, a banquet server makes $10 an hour and works 45 hours in one week, plus receives $200 from the service charges for that week. The employer pays the straight time of $450 for the 45 hours, but the overtime rate for the 5 additional hours is $7.22 an hour, not $5 an hour. Instead of getting $25 in overtime, the server receives $36.11. The total paycheck before taxes is $486.11. Had the server not received the service charges, the total paycheck would be $475 before taxes.
While the difference in pay may appear insignificant, it is not in the eyes of the law, or the employee. Even small errors can add up to big losses for businesses.
Protect Your Business:
Businesses should audit their pay practices at least annually to ensure compliance with federal, state and local laws. Enlist the services of legal and tax professionals who are well versed in this area. It is better to find and correct your own mistakes now, rather than hearing from a government agency or plaintiff’s lawyer later. By the time your business is being investigated or sued, the doorway out will likely come with a hefty price tag.
For more information contact the author at MAnderson@laborlawyers.com or 504.522.3303.