Tipped Employee

A tipped employee is defined as an individual who routinely receives more than $30 per month in tips from customers as part of their regular job duties. These workers rely on gratuities, usually in the form of cash or card-based tips, as a substantial portion of their income. Common roles that fall into this category include restaurant servers, bartenders, baristas, hairstylists, taxi drivers, bellhops, and casino dealers.

The status of being a tipped employee affects how an employer compensates that worker and what minimum wage laws apply. Employers are permitted, under certain conditions, to pay these employees a lower hourly rate than the standard minimum wage—known as the tipped minimum wage—based on the assumption that tips will make up the difference. However, the employer is still legally responsible for ensuring that total earnings (wage plus tips) meet or exceed the applicable full minimum wage.

Payroll for Tipped Employees

Payroll for tipped employees involves unique considerations, since their earnings are comprised of both employer-paid wages and customer-paid tips. Employers must track both components accurately to comply with wage laws and tax regulations. While tips may not originate directly from the business, they are still considered taxable income and subject to payroll taxes under federal law.

Employers typically collect tip information through Point of Sale (POS) systems or require employees to submit tip reports regularly—either daily or monthly. Tip amounts must be included on pay stubs and W-2 forms to ensure accurate calculation of Social Security, Medicare, and federal income taxes.

Credit card tips are often collected by the employer and paid out during scheduled payroll runs. These tips are taxed just like regular wages. Cash tips, while given directly to employees, must also be declared for taxation and reporting. Failure to account for cash tips accurately can result in legal issues for both the employee and employer.

Employers are also allowed, under federal law, to deduct credit card processing fees from tips—usually a small percentage such as 2% to 3%. However, this practice must follow state labor laws, as some states prohibit employers from reducing tips under any condition.

Labor Laws for Tipped Employees

Labor laws for tipped employees are governed by both federal regulations and state-specific legislation. The Fair Labor Standards Act (FLSA) outlines federal protections, while individual states may impose stricter standards.

Under the FLSA, employers may pay tipped workers as little as $2.13 per hour in direct wages, provided that the employee’s total earnings (including tips) equal or exceed the standard federal minimum wage of $7.25 per hour. This difference is known as the tip credit. If the employee’s tips do not bring their total hourly pay up to the minimum wage threshold, the employer must make up the shortfall.

In addition to wage requirements, tipped employees are entitled to overtime pay for hours worked beyond 40 in a workweek. Overtime must be calculated based on the full minimum wage rate, not the reduced tipped rate.

Tip pooling and tip sharing are also addressed by labor laws. Tip pooling allows multiple employees (such as servers and bussers) to combine tips and redistribute them equally or proportionally. This is legal so long as it excludes managers and employees who do not provide direct customer service. Tip sharing, where a portion of an employee’s tips is distributed to support staff, is also legal if it follows proper disclosure and includes only eligible team members.

Some states have laws that override the FLSA, requiring higher minimum wages or eliminating the tip credit entirely. In these states, tipped workers must be paid the full state minimum wage, and tips are treated as supplemental income.

Minimum Wage for Tipped Employees

The minimum wage for tipped employees refers to the base rate an employer must pay a tipped worker before accounting for tips. At the federal level, the tipped minimum wage is $2.13 per hour. This rate is allowed only when tips raise the employee’s total hourly earnings to at least $7.25—the standard federal minimum wage. The difference of $5.12 per hour can be claimed by the employer as a tip credit.

However, many states enforce their own wage laws that set a higher tipped minimum wage or prohibit tip credits altogether. For example, in California, tipped employees must receive the full state minimum wage directly from the employer, with tips considered separate and additional.

If an employee does not earn enough in tips during a given pay period to meet the applicable minimum wage, the employer is legally obligated to compensate the difference. Failing to do so may result in wage violations, penalties, or lawsuits.

Employers must maintain accurate records of all wages and tips to demonstrate compliance. This includes daily tip reports, wage statements, and timekeeping records.

Conclusion

Managing tipped employees requires a solid understanding of compensation rules, labor laws, and tax obligations. From maintaining accurate payroll records to ensuring compliance with minimum wage laws, employers must stay informed and proactive. Tipped employees play an essential role in many service-based industries, and fair, lawful compensation practices are crucial to maintaining a positive and compliant work environment.