The Federal Tipped Minimum Wage
Under the Fair Labor Standards Act (FLSA), employers can pay tipped employees as little as $2.13 per hour in cash wages, provided the tips received bring total hourly earnings to at least the federal minimum wage of $7.25. This is the federal "tip credit." However, many states have higher tipped minimum wages or have eliminated the tip credit entirely — California, Alaska, Minnesota, Montana, Nevada, Oregon, and Washington all require paying the full state minimum wage to tipped employees with no tip credit.
The Tip Credit Notice Requirement
Before taking the tip credit, employers must inform tipped employees: the amount of the cash wage paid (at least $2.13), the amount of the tip credit (up to $5.12 to reach $7.25), that all tips received are retained by the employee (except in valid tip pools), and that the tip credit will not be taken if tips received in any workweek do not bring total wages to the minimum wage. Failure to provide this notice means the employer cannot take the tip credit — they must pay full minimum wage plus keep the tips.
Tip Pools
Tip pooling — sharing tips among employees — is legal under the FLSA with important restrictions:
- If the employer takes a tip credit: only employees who customarily receive tips (servers, bartenders, bussers) can participate. Managers, supervisors, and back-of-house staff cannot participate.
- If the employer pays full minimum wage (no tip credit): back-of-house staff (cooks, dishwashers) may be included in the tip pool. Managers and supervisors still cannot participate.
Employers and their managers can never keep any portion of employee tips, regardless of payment method.
Mandatory Service Charges
An automatic service charge (e.g., 18% added for parties of 6+) is not legally a tip — it is revenue belonging to the employer. The employer decides how much, if any, goes to employees. However, if employees receive service charge distributions, those amounts are taxable wages, not tips. The IRS treats mandatory service charges differently from voluntary tips, with different withholding and reporting implications.
Credit Card Tip Processing
When customers tip on a credit card, the employer may deduct a proportionate share of the credit card processing fee from the tip before paying it to the employee. If the processing fee is 2.5%, the employer can remit 97.5% of the credit card tip. Tips must be paid to employees no later than the regular payday for the period in which they were received.
POS and Payroll Integration for Tip Compliance
Your POS system must accurately track all tip income by employee and pay period. This data feeds payroll to ensure tip credit calculations are correct, taxes are withheld on tip income, and the IRS Form 8027 (Employer's Annual Information Return of Tip Income) can be filed accurately. A POS that cannot report tips by employee and day is a compliance liability.
