There has been a surge of interest in low-wage workers, tipped workers and wage theft by employers in the food industry. It is important for workers to know their rights, especially in minimum-wage jobs. Knowing your rights can help prevent wage theft.
The following is a primer on tipped employees, with an emphasis on the valid tip pool. But first, let's look a the definition and basic rights of a tipped employee.
A tipped employee is defined in federal law as a person who customarily and regularly gets at least $20 per month in tips. A tip is a monetary amount freely given by a customer in exchange for services provided. If a "tip" is not freely given - for instance, if an amount is bargained for as part of a catering contract, or if there is a policy that fixes the amount of a gratuity for tables of six or more - that is not a tip; it is a service charge. (This is new in the law as of Jan, 1, 2014.) While the two are similar, there are slight variations in how they are treated for tax purposes.
The IRS gives the following examples of non-tip gratuities:
Large Party Charge (restaurant),
Bottle Service Charge (restaurant and night-club),
Room Service Charge (hotel and resort),
Contracted Luggage Assistance Charge (hotel and resort), and
Mandated Delivery Charge (pizza or other retail deliveries).
One important feature of such service charges is that they cannot be applied to the tip credit. If a pizza delivery person works for an establishment that automatically tacks on a $2.00 "tip" for every delivery, and the employee does not make any other tips, the employee is not a tipped employee and must be paid the normal minimum wage, even if the driver gets to keep 100% of the delivery charges. Even if she does get additional tips from customers, the delivery charge must be kept separate from the real tip for purposes of calculating the tip credit.
A tipped employee must report, for purposes of taxes, 100% of actual tips and service charges received. Under the tax code, an employer with more than 10 employees must report to the IRS any employee who does not report receiving tips equal to at least 8% of gross sales of items for which they regularly receive tips. Employers do this by calculating the difference, and reporting that difference as "allocated tips." Employees do not automatically pay taxes on allocated tips; it is merely a reported discrepancy.
An employer who operates a large food or beverage establishment is required to allocate among tipped employees an amount equal to the excess of eight percent of the gross receipts of such establishment for the payroll period over the aggregate amount of tips reported by employees at such establishment to the employer. See Treas. Reg. 31.6053–3(d).
Because employers are often loathe to do more paperwork, they often require employees to report 8% of sales. This is illegal, most especially when it requires a tipped employee to report more than he actually earned in tips.
In the food industry, tipped employees are often assisted by other tipped employees in providing service. The obvious example is a server who works with a bartender. When the bartender takes time to prepare drinks for a server, she is taking time away from her own customers and losing out on her own tips. The IRS therefore allows for valid tip pools, wherein tipped employees may pool their tips. The operative phrase, however, is "tipped employees." The pool may not include non-tipped employees.
Thus, it is illegal for an employer to collect tips from servers and pay them to cooks, although this is a common practice. It is the responsibility of the employer to compensate the cooks, not the servers. However, this provision has been litigated, and some courts have held that the "valid tip pool" rule can only apply when the employer takes advantage of the tip credit and pays tipped employees less than the normal minimum wage.
The penalty for a violation can be severe for the employer. The employer must repay all tips illegally taken. Also, during the time of the violation, all federal tip credit is forfeited. The federal minimum wage for tipped employees, after the tip credit, is $2.63. The normal federal minimum wage is currently $7.25 per hour. If an employer violates this section of the law, she must repay the tips and pay the regular minimum wage.
For example, in a state that follows the federal tip credit and allows an employer to pay $2.13 per hour, an employer would have to repay the stolen tips and go back and pay the tipped employee an additional $5.12 per hour for each hour worked.
Most states have a smaller tip credit than the Feds, meaning they have a higher minimum wage for tipped employees. Except in those few states that have no tip credit at all, this provision still comes into effect. Thus, in those states where the minimum wage for tipped employees is $4.86 per hour, a violating employer would still have to make up the difference between $4.86 and the federal minimum wage of $7.25.
Moreover, the penalty may apply even if the employer does not adopt an illegal tip pool. This is because the Department of Labor requires all employers with tipped employees to inform employees of these provisions of the law. Failure to inform is sufficient to invoke the penalty.
Requirements
The employer must provide the following information to a tipped employee before the employer may use the tip credit:
1) the amount of cash wage the employer is paying a tipped employee, which must be at least $2.13 per hour;
2) the additional amount claimed by the employer as a tip credit, which cannot exceed $5.12 (the difference between the minimum required cash wage of $2.13 and the current minimum wage of $7.25);
3) that the tip credit claimed by the employer cannot exceed the amount of tips actually received by the tipped employee;
4) that all tips received by the tipped employee are to be retained by the employee except for a valid tip pooling arrangement limited to employees who customarily and regularly receive tips; and
5) that the tip credit will not apply to any tipped employee unless the employee has been informed of these tip credit provisions.
The employer may provide oral or written notice to its tipped employees informing them of items 1-5 above. An employer who fails to provide the required information cannot use the tip credit provisions and therefore must pay the tipped employee at least $7.25 per hour in wages and allow the tipped employee to keep all tips received.
Many readers may have seen the episode of Gordon Ramsey's Kitchen Nightmares where a restaurant in Arizona was owned by a couple of real doozies. It is the only episode I have ever seen where Ramsey gave up and walked out. The owners claimed to pay their server at least minimum wage (maybe higher, I can't remember), but then kept all the tips. The customers were unaware that the owners took the tips, and some customers said they tipped more generously than normal because of the abuse the server took from the owners. Assuming the owners actually paid the server at least $7.25 per hour, I honestly do not know what penalty they would face, other than returning the tips.
For more detailed information, see This IRS publication or the more readable Department of Labor Fact Sheet.