Management & Operation

Understanding Tip Credits

Last updated on Feb 15, 2022
Michale LeRoy

The topic of tip credits can be confusing for business owners and employees, but it’s important to understand the role that tip credits play in minimum wage calculations. Approaching tip credits the right way ensures that your employees are fairly compensated and your taxes are prepared correctly. You’ll also improve your employee retention rate. We’ll break down the basics of tip credits and explain the latest requirements.

Already understand tip credits? Jump to the latest updates from the US Department of Labor.

What Is a Tip Credit?

cash

Claiming a tip credit is a legal way for employers to count employee tips towards their obligation to pay minimum wage. Employers do not "take" the tip credit away from employees. It’s simply a figure that is used in minimum wage calculations. Tip credits show the federal government that Employee A has made enough money in tips that they don’t need to be paid the full minimum wage.

What Employers Need to Know About Tip Credits - Employees must be paid the federal minimum wage unless you're claiming a tip credit for them. You must provide written or verbal notice that you're claiming a tip credit.

What Workers Need to Know About Tip Credits - If employers are claiming a tip credit for you, it must be accurately declared on a pay stub and/or tip credit report. You keep all your tips, and tip credits don't take anything away from your pay. In fact, if you aren't making enough money in tips, a tip credit can help you get paid more.

If that doesn't clear things up, you're not alone. Tip credits are notoriously confusing, so we'll give a deeper explanation below.

What Is a Tipped Employee?

First of all, what are tipped employees? According to the Fair Labor Standards Act (FLSA), tipped employees are described as any employee who regularly receives more than $30 per month in tips. Restaurant servers probably come to mind, but tipped employees also include valet staff, delivery drivers, and bartenders.

What Is the Minimum Tip Wage?

The amount of gratuity that tipped employees earn usually exceeds the federal minimum wage ($7.25 an hour), so employers are allowed to pay these employees less than the standard minimum. This is called the minimum tip wage. Every state sets its own tipped minimum wage, but it must meet the federal requirement of at least $2.13 an hour. Many states, like California and Washington, pay a much higher tipped minimum wage. The US Department of Labor website provides more info on minimum wages for tipped employees by state.

What If Employees Don’t Make Enough Tips?

Did you know that employers are required to pay tipped employees the federal minimum wage ($7.25) if they don’t make enough tips in one pay period? You might be thinking, "Hold on, what about the tipped minimum wage?" Even though tipped employees can legally be paid the lesser tipped minimum wage ($2.13), it is only with the understanding that their tips and wages combined will be equal to or greater than $7.25.

When tips plus wages don't equal $7.25, the employer must make up the difference. Since many tips are cash, how does the federal government know that employees are making enough tips to meet minimum wage? This is where tip credits come into play.

How To Calculate a Tip Credit

female worker in apron tallies up tip credits with calculator on phone

To legally prove a tipped employee is making enough money, the tip credit should be declared on a pay stub and/or a tip credit report. Tip credits are calculated on a weekly or bi-weekly basis, depending on the pay schedule. It's also the employer's responsibility to explain tip credits to their tipped employees verbally or in writing. Every state sets a maximum tip credit, but the federal max tip credit is $5.12 per hour ($7.25 min wage - $2.13 tipped min wage = $5.12 max tip credit).

Many POS systems can be set up to perform this function automatically, but a tip credit calculation would look something like this:

Hours Worked: 30 hours

Total Tips Earned: $375

Max Tip Credit: $5.12 / hour

Divide the total number of tips by the hours worked to calculate how much the server has earned per hour for that pay period.

$375 tips ÷ 30 hours = $12.50 per hour

$12.50 per hour is greater than the maximum tip credit of $5.12, so the server has made enough money in tips. The employer can claim the full tip credit of $5.12 and has no further obligation to pay the employee additional wages. Remember, the employer is not taking the tip credit away from the employee. The tip credit represents the amount the employer doesn't have to pay. Let's take a look at a tip credit calculation that is less than the max tip credit:

Hours Worked: 30 hours

Total Tips Earned: $120

Max Tip Credit: $5.12 / hour

$120 tips ÷ 30 hours = $4 / hour

Because $4 per hour is less than the tip credit of $5.12, the employer can only claim $4 toward their obligation to pay minimum wage. They must make up the difference on the employee's paycheck.

$5.12 tip credit - $4 / hour = $1.12 / hour

$1.12 / hour x 30 hours = $33.60

The employer pays an additional $1.12 an hour to this employee for a total of $33.60 added to their normal wages.

Updates to Fair Labors Standards Act (FLSA)

waitress wiping wooden table with cloth

Restaurant owners know that servers and waitstaff perform a lot of duties besides just serving their customers. Sidework duties for servers could include sweeping the floors around their section, keeping salt and pepper shakers filled, or filling the ice at their beverage station. Many of these duties are necessary to be able to serve customers, but there are instances when tipped workers should be compensated for performing non-tipped labor and dual jobs. The most recent updates to the Fair Labor Standards Act divide a tipped employee’s duties into three categories:

  1. Tip-producing work - Tasks that provide a service to customers and result in a tip
  2. Directly supporting work - Duties spent preparing for tip-producing work or assisting others with customer service work that results in a tip
  3. Work that is not part of a tipped occupation - Any tasks that do not result in a tip and do not support tip-producing work

Note: Any time spent performing work that is not part of a tipped occupation (C) will be compensated at the full minimum wage and a tip credit cannot be claimed. Examples of this type of work would be requiring servers to clean the kitchen or restrooms, perform accounting duties, or prepare food items.

What Is the 80/20 Rule?

The final ruling on the 80/20 rule that went into effect in December 2021 states that there is a 20% limit on time spent performing non-tipped duties. If a server spends more than 20% of their total workweek performing duties that fall into the directly supporting work category (B), they must be paid full minimum wage for that time and the employer can’t claim a tip credit.

What Is the 30 Minute Rule?

Under the 30 minute rule, if a server spends more than 30 minutes performing directly supporting work (B), they must be compensated at full minimum wage for all time exceeding 30 minutes. For example, the employee opens the store and spends 35 minutes setting up the beverage stations. They must be paid for the time exceeding 30 minutes (5 minutes) and the employer cannot claim a tip credit for this time.

What About Idle Time?

Sometimes business is slow and servers wait a considerable amount of time for a table. According to the Department of Labor, this idle time is included in directly supporting work (B). This means that idle time that exceeds 30 minutes needs to be fairly compensated at minimum wage with no tip credit.

What Employers Need to Know About the Updates for Tipped Employees - In general, you'll need to pay closer attention to the sidework duties your servers are performing and for how long. You'll need to recognize the difference between duties that support earning tips versus duties that have nothing to do with tips. If you have servers on the clock and they have no tables to wait on, you have to pay them fairly for the time they spend on sidework duties.

What Workers Need to Know About the Updates for Tipped Employees - If you regularly spend time on non-tip producing labor when you have no tables to serve, keep track of how long you're performing these duties. You may deserve a better pay rate if the time equals out to more than 30 minutes of continuous work or 20% of your entire workweek. The idle time when you have no tables is also included.


Calculating compensation for tipped employees does come with its challenges. Banning the tipping system altogether is an idea that some restaurant owners have tried, but it has failed to gain support from the majority of employers and employees. The truth is, working for tips can be very profitable and it lowers the labor cost for operators. Understanding and abiding by compensation laws is the best way to make sure your tipped employees are treated fairly and the tipping system continues to be beneficial for all.

The information provided on this website does not, and is not intended to, constitute legal advice. Please refer to our Content Policy for more details.
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