Litigation costs of even a successful defense of a Fair Labor Standards Act case can be tens of thousands of dollars. Damages in an unsuccessful case include the wages found to be owed, liquidated damages in the same amount, plus attorney fees and costs, and can be crippling. Furthermore, settlement of an FLSA claim is effective only if approved by a federal court or the U.S. Department of Labor, which can invite further inquiry into an employer's wage and tax practices.

Tip sharing and tip pooling long have been a part of wage-and-hour law concerns for those in the hospitality industry. Their use derives mainly from a credit (the tip credit) employers may take against their minimum wage obligations. Given this lengthy history, it might be assumed that the law is well understood and applied properly. A 2008 class action award against Starbucks in excess of $100 million arising out of a tip-pool arrangement suggests otherwise.

Minimum Wage and Tip Credits

Employers engaged in interstate commerce or which have annual sales of $500,000 or more are subject to the FLSA and are required to pay nonexempt employees (including tipped employees) a minimum wage (currently $7.25 per hour), as well as overtime at one-and-a-half times the minimum wage for hours worked over 40 in a work week. For tipped employees, however, employers may take a tip credit against the minimum wage currently of up to $5.12 per hour. Stated otherwise, employers must pay their tipped employees a cash wage of $2.13 per hour if the employees receive tip income of at least $5.12 per hour. If an employee's tip income when combined with the employer-paid wage of $2.13 per hour does not equal the minimum wage of $7.25 per hour, the employer must make up the difference. The tip credit may be taken only if the employee is permitted to keep all tips, except as might be altered by a lawful tip pool.

Before an employer may avail itself of a tip credit, the employer must provide the following information to its tipped employees:

• The amount of the cash wage the employer is paying the employee, which must not be less than the mandated tip wage currently set at $2.13 per hour;

• The amount claimed as a tip credit by the employer, which may not exceed the difference between the tip wage (i.e., currently $2.13 per hour) and the minimum wage (currently $7.25 per hour) or currently not in excess of $5.12 per hour;

• That the tip credit taken by the employer may not exceed the amount of tips actually received by the tipped employee;

• That all tips received by a tipped employee must be retained by that employee, except for a valid tip-pool arrangement (see discussion of tip-pools below); and

• That the tip credit will not apply to any tipped employee who is not informed of the foregoing.

Who Is a Tipped Employee?

A tipped employee, is one who "customarily and regularly" receives more than $30 per month in tips. Taking a tip credit against the minimum wage applies only to properly classified tipped employees. Employees who only occasionally earn more than $30 a month in tips as a result of holidays, special events or filling in on shifts for other employees are not tipped employees.

What Is a Tip?

A tip is an amount voluntarily paid by a customer as a gift or gratuity for service performed. It may not be required or influenced by the employer. Generally, cash tips and tips left on credit cards or checks are valid tips. Mandatory service charges or gratuities imposed by employers are not tips, but payments directly to the owner of the establishment, and may not be counted as tips for determining who is a tipped employee. A differentiation between tips and service charges is important because tips belong to the employee, not the employer, and may be used by the employer only for a tip credit and for no other purpose.

What Is Tip Sharing?

Tip sharing occurs when a tip is shared with another employee who assisted the tip recipient in serving the customer. Typically, this includes other "front-of-the-house" employees, such as bus persons, bartenders and hosts. An employer may not require tipped employees to share their tips. Tipped employees may voluntarily share tips with tipped or nontipped employees, including "back-of-the-house" employees. There is no limit on the amount of a tipped employee's tips that can be shared with other employees.

If employees determine to have a tip-sharing arrangement, the employer may participate in its administration by collecting and distributing the tips. If it does, the employer should insist that the arrangement is in writing. If the employees refuse to put the arrangement in writing, the employer may refuse to participate in collecting and distributing tips. However, if the employer is taking a tip credit, it necessarily will have to have information regarding the tips and their distribution to individual employees to properly apply the tip credit. For this reason, refusing to participate can be problematic.

Tip-sharing agreements can be difficult for employers. Some tipped employees might refuse to share with others, and employees are free to move in and out of a tip-sharing arrangement at will. This can complicate the employer's record-keeping to assure proper application of a tip credit to each employee.

What Is Tip Pooling?

Tip pooling is the comingling and distribution of tips of all or some tipped employees. Tip pools differ from tip sharing, in that tip sharing must be voluntary; tip pooling may be required by the employer.

A potentially difficult problem is determining who may participate in a tip pooling arrangement for purposes of the tip credit. The tip credit is available only for employees who "customarily and regularly receive tips of more than $30 per month." Generally, bellhops, bussers, counter personnel, service bartenders, waiters and waitresses, and hosts and hostesses (i.e., employees having direct contact with the customer) are eligible to participate in tip pooling. Employees engaged as bakers, chefs, cooks, dishwashers and janitors generally may not participate in tip pooling when the employer takes a tip credit, but may participate in tip sharing arrangements. Managers and supervisory staff generally may not participate in tip pooling.

Another issue is whether an employee who otherwise does not customarily and regularly meet the $30 per month tip requirement may participate in a tip pool if, solely as a result of participating in the pool, he satisfies the $30 per month requirement. The majority of courts have held that an employee who satisfies the $30 per month tip income requirement by virtue of participating in a tip-pool will satisfy the test for application of a tip credit. Other courts look to see if the employee has regular contact with the tipping customer and, in such cases, hold that the $30 per month test can be satisfied by participation in the tip pool.

Why Have Tip Pools?

Tip pools are useful where many individuals participate in giving service to the customer, even though there is only one point of sale at which a tip is left. For example, in bars, casinos, restaurants or cafes, hosts and hostesses, bussers, waiters and waitresses all might provide service to the customer, but the tip is left only for the waiter or waitress. Dividing the tip among all those who provide service to the customer can bring fairness to the workplace that might otherwise be viewed as unfair. Another example would be sharing tips across work shifts where one shift is likely to receive more in tips than another, notwithstanding that the same work is performed.

Common Issues With Tip Pools

Employees may not be required to contribute a greater percentage of their tips than is customary and reasonable. The Department of Labor has stated that, for enforcement purposes, it will not question contributions to a tip pool if the net amount of tips contributed (after a return of any tips from the pool) does not exceed 15% of the employee's tips; however, only those tips that are in excess of tips used for the tip credit may be taken for a pool.

Occasionally, employees will perform jobs, part of which are tipped and part of which are nontipped. For example, a waiter might spend time setting tables, cleaning, making coffee or preparing salads. For these "dual job" classifications, the employer might be limited in applying the tip credit to the time spent performing the nontipped duties. For tipped employees who spend a substantial amount of time (in excess of 20% of the work week) performing duties that do not relate to the tip, no tip credit may be taken for the time spent performing those duties. The employer must pay the full minimum wage for that time. This is known as the "80/20" rule.

In November 2018, the DOL issued an opinion letter purporting to supersede prior interpretations of regulations that established the 80/20 rule by eliminating any limitation on the amount of duties related to a tip-producing occupation that may be performed, so long as those duties are performed substantially contemporaneously with direct customer service duties. That interpretation gave employers much greater flexibility in having tipped employees perform nontipped duties. In Belt v. P.F. Chang China Bistro, Civ. Action No. 18-3831 (E.D.P.A. Aug. 15, 2019), the court ruled that this interpretation was impermissible and restored the 80/20 rule in this district. Other federal courts also have likewise interpreted the "dual jobs" regulations as imposing a 80/20 test.

Occasionally, employers will deduct from an employee's wages for such things as breakage, uniforms, unpaid customer checks or cash register shortages. Employers must be sure that such charges do not reduce the employee's wages below the minimum wage. Furthermore, where a tip credit is claimed, the tipped employee is considered to have been paid only the minimum wage for all nonovertime hours worked in the tipped occupation. The employer may not take deductions for shortages, breakage, the cost of uniforms, etc. in such circumstances because, to do so, would reduce the tipped employee's wages below the minimum wage.

Employers must correctly calculate overtime when a tip credit is used. Where an employer takes a tip credit, overtime must be calculated on the basis of the full minimum wage, not the cash wage. For example, a tipped employee working six hours of overtime in a week would have overtime pay calculated as follows: 6 x $7.25 x 1.5 = $65.25, minus $2.13 x 1.5 x 6 = $19.17 or $46.08.

The timing of paying tips also can be problematic. When a tip is left on a credit card, the employer may deduct from the tip any service charge the credit card company charges the employer. But the employer must pay the tip income to the employee not later than the next regular pay day. It cannot wait until the credit card company pays the employer.

An issue resolved to a large extent is whether an employer may require tipped employees to put tips into a tip pool, which the employer then uses to pay nontipped employees. Doing so permits an employer to show fair treatment to its back-of-the-house employees by allowing them to share the customers' gratuity for services those nontipped employees perform and that benefit the customer. For example, it allows an employer to increase the wage of a chef, other food preparers and dishwashers by sharing with them the tip received by the waiter or waitress.

The argument advanced against this procedure is that it effectively uses tips earned by servers to pay nontipped employees. An Obama-era regulation prevented employers from using tip pools to pay back-of- the-house employees.

A 2018 spending bill has changed that regulation. It is still the case that tip money may never be kept by the employer or used to pay managers (at least not when they are acting as managers). Nor may employers require tipped employees to share their tips with back-of-the-house employees unless all employees are paid at least the state minimum wage (which can be higher than the federal minimum wage.)  If the state minimum wage is paid to all employees (including the tipped employee), the employer may require tip pooling and share tips with back-of-the- house employees. This will address employer pay equity concerns but will prevent employers from "punishing" tipped employees by paying them a tip wage while requiring them to share their tips with back-of-the- house employees.

The new law leaves some questions unanswered. For example, if a manager fills in a shift as a server or bartender may the manager share in a tip pool? It is clear that the manager may keep tips actually received, but if there is a tip pool must he contribute to the pool and may he share in that pool? A tip credit is available only for employees who "customarily and regularly" receive tips of more than $30 a month. It is unlikely (but not impossible) that a manager would meet that definition. In most cases, therefore, a manager will be able to keep tips he actually receives but will not be required or able to share in a tip pool.

Most importantly, the law imposes substantial new fines for a violation including a civil penalty of $1,000 per violation plus having to reimburse the employee the wage due. This is in addition to the usual penalties under the FLSA that include liquidated damages equal to the unpaid wages and attorney fees and costs.

Robert W. Small is a partner in Reger Rizzo & Darnall's employment practices group. Contact him at [email protected] or 215-495-6541.