Evolution of Wage Issues in the Restaurant Industry

Last week, the U.S. Department of Labor announced a proposed rule for tip provisions of the Fair Labor Standards Act (FLSA) implementing provisions of the Consolidated Appropriations Act of 2018 (CAA). The proposal would also codify existing Wage and Hour Division (WHD) guidance into a rule. Compliance with the FLSA has long confounded restaurant industry employers (among others), and FLSA-related litigation continues to flood the courts. 

In particular, what employers do not know about the tip credit can expose them to liability including collective or class actions. The consequence of a violation is the potential to lose the tip credit making the employer liable for the difference between the tip credit minimum wage and federal minimum wage for each tipped employee with that amount liquidated (doubled) for a period of two years-three if the violation is found to be willful. 

The majority of restaurants implement both tip credits and tip-pooling arrangements. Although these wage plans are commonplace, their technicalities are difficult for employers to correctly implement and seemingly more difficult to monitor. While there are many common restaurant industry pitfalls, these can be avoided through careful planning and best practices that restaurants should incorporate. Presented below are several key concepts that employers should bear in mind when it comes to tip credits and tip-pooling arrangements. 

Employers Must Properly Notify Tipped Employees of the Tip Credit

Employers may only take a tip credit under the FLSA if they inform employees of the FLSA tip credit provisions before the employees become tipped employees. Prior to taking any tip credit with respect to any employee’s wages, employers must first notify tipped employees of the following: (1) the amount of the direct cash wage per hour, (2) any additional amount the employer intends to claim as a tip credit, (3) that the tip credit cannot exceed the amount of tips received by the employee, (4) that employees must retain all tips except where there is a valid tip-pooling arrangement, and (5) that the tip credit will not apply until the employer notifies the employee.

Limit Tip Pools to Eligible Employees

The FLSA allows arrangements in which employees contribute a percentage of their tips to be distributed to other employees. However, only employees who customarily and regularly receive tips are eligible to participate in a tip pool. Customer interaction is the cornerstone of whether an employee may participate in a tip pool. In the food services industry, courts have permitted the following employees to participate in tip pooling because they have sufficient direct customer contact: (1) wait staff, (2) counter personnel who serve customers, (3) service helpers and bussers, (4) food runners and expeditors, (5) service bartenders, and (6) hosts. Conversely, courts have determined the following employees are ineligible for tip pooling because they do not interact routinely with customers: (1) chefs, (2) cooks, (3) dishwashers, and (4) janitors.

Allowing ineligible employees to participate in tip pools is a common employer error. Employers should prohibit “back of the house” and management-level employees from participating in a tip pool. Compliance with the DOL’s regulations on this issue, however, requires employers to actively monitor whether employees are following their policies. Employers should consider implementing a daily tip allocation or distribution worksheet and should require employees to use it to record tip amounts distributed to other eligible employees in the pool.

The 2018 Consolidated Appropriations Act contains language that addressed tip pooling and employers who do not take a tip credit. The legislation provides that, if employers pay a direct wage of at least minimum wage, they can require that employees who do not regularly and customarily receive tips (such as “back of the house”) may participate in the tip pool. However, the tips otherwise belong to the employees. In response, the Department of Labor announced that it would issue proposed rules addressing the Congressional Act.  Over a year later, no such rules have been issued. 

Mandatory Versus Voluntary Tip Pools

Current DOL regulations specifically envision both voluntary tip pools and mandatory tip pools and treats each differently. Thus, knowing whether employees are tipped pursuant to a voluntary or mandatory tip pool is essential. In a “voluntary” tip pool, employees agree among themselves to include employees who may not regularly and customarily receive tips from patrons. Voluntary tip pooling must be truly voluntary and free of employer coercion, control, or involvement in the tip distribution.

The DOL regulations separately provide the following requirements for employers who establish mandatory tip pools: (1) only employees who “customarily and regularly receive tips” can participate, (2) the “employer must notify its employee of any required tip pool contribution amount,” (3) the employer “may only take a tip credit for the amount of tips each employee ultimately receives,” and (4) the employer “may not retain any of the employees’ tips for any other purpose.” Unlike voluntary tip-pooling arrangements, an employer can enforce mandatory tip pools and can discipline an employee who fails to share tips with a member of a mandatory pool. Additionally, employers can take a tip credit against their minimum wage obligations for all tipped employees who participate in a mandatory tip pool.

Tipped Employees Must Earn Minimum Wage

As employers navigate the restrictions on tip credits and tip pooling, a commonly overlooked issue is whether tipped employees are actually earning the minimum wage for all hours worked. The employer can only meet its minimum wage obligation to tipped employees by combining the employee’s direct hourly wage and the employer’s tip credit. In other words, employers cannot use the tips employees receive above the amount of the tip credit to satisfy the FLSA-mandated minimum wage obligation.

Additionally, DOL regulations require all employees to receive the requisite minimum wage “free and clear,” and employers cannot take deductions that reduce wages below the applicable minimum.  The same limitation applies to the wages of tipped employees. If the permitted tip credit combined with the direct wage is less than the required minimum wage, the employer must make up the difference.  When employees are only earning a reduced direct wage plus a tip credit, employers must be careful that minimum-wage employees do not incur employment costs such as deduction for uniforms, breakage or walk outs that cause them to fall below the minimum wage.

Tipped Employees Are Entitled to Overtime Wages

As with other FLSA-covered employees, tipped employees must receive overtime wages for all hours worked in excess of 40 hours in a given workweek.  Employers make two common mistakes: (1) they do not properly calculate the tipped employee’s “regular rate” because they fail to include the tip credit or (2) they take advantage of the tip credit twice, once from the direct wage and once from the overtime premium. Employers must include all compensation in the regular rate for overtime purposes, with the exception of tips received from customers. 

Impact of Mandatory Service Charges on Minimum Wage and Overtime

Another potential calculation problem relates to mandatory service charges and gratuities restaurants impose on customer bills. DOL regulations provide that service charges do not constitute tips, regardless of whether the service charge is labeled as a gratuity or tip on the customer bill.  However, if employers distribute service charges to employees, the service charges should be included in the employee’s direct wages. Thus, service charges paid to employees count towards the minimum wage obligation. Therefore, an employer has discretion in distributing service charge funds. If a service charge is divided among a group of employees, an employer may only count the portion or percentage that a particular employee receives toward that employee’s minimum wage. Employers must also bear in mind that the IRS now requires employers to report automatic gratuities on employee payroll checks as a separate component of the employee’s wages.

Side Work and Training Time Can Affect the Tip Credit

“Side work” and trainings are commonplace throughout the restaurant industry. While seemingly minor parts of the workday, these tasks can impact required minimum and overtime wages because FLSA regulations only permit employers to take a tip credit for hours the employee actually performs tipped work.  However, the law recognizes that, at times, a tipped employee will perform work incidental to the actual service that provides tips.  For example, a waitperson may spend time cleaning and setting tables, toasting bread, making coffee, and occasionally washing dishes or glasses.  These are all considered incidental duties to the tipped occupation.  Thus, employers may take a tip credit for time spent on incidental duties provided the overall time spent on incidental duties does not exceed 20 percent of the tipped employee’s total work time in a workweek.

Likewise, requiring employees to attend training sessions or pre and post-shift meetings is compensable work time. Employers may take a tip credit for training time if the training is incidental to the service for which the tip is provided.  The employer, however, cannot claim a tip credit if the training time exceeds 20 percent of the employee’s total work time in a workweek.

While employers struggle to comply with the FLSA, tipped employees present unique challenges. Counsel and employers must understand the nuances of compensating tipped employees. If done properly, utilizing the FLSA’s tip credit can save employers significant labor costs. Employers’ mistakes or miscalculations, however, can cost employers far more in time, money, and resources.