Tipped Employee Payroll Laws

Like most non-tipped workers, tipped employees are generally subject to the Fair Labor Standards Act (FLSA) and other applicable employment laws. However, the payroll rules surrounding tipped workers are often more complicated than for non-tipped employees.

This guide covers the fundamentals of paying tipped employees, including:

• Definition of tipped employee
• Federal tipped minimum wage
• State tipped minimum wage
• Who tips belong to, and tip pooling arrangements
• Overtime for tipped workers
• Payroll tax rules for tips
• Federal Insurance Contributions Act (FICA) tip credit
• Voluntary tip reporting compliance program

Who is a tipped employee?

“Tipped employees are those who customarily and regularly receive more than $30 per month in tips,” according to the United States Department of Labor (DOL).

Tipped employees work in service industries and businesses, such as:

• Hotels, motels, and inns
• Restaurants and bars
• Casinos
• Hair salons
• Cosmetology services
• Barber shops
• Vehicle parking services (e.g., valet)
• Local passenger transportation (e.g., limousine services)
• Deep sea passenger transportation
• Passenger railroad services

The FLSA applies to most U.S. employers — so if you have tipped employees (not independent contractors), then they are likely covered by the FLSA.

The DOL oversees the FLSA, which governs federal minimum wage, overtime, child labor, and recordkeeping laws. The FLSA applies to most U.S. employers — so if you have tipped employees (not independent contractors), then they are likely covered by the FLSA.

What is the federal tipped minimum wage?

The federal minimum wage is currently $7.25 per hour. You can pay tipped employees less than the federal minimum wage if they earn enough tips to make up the difference. In this case, you can claim what’s called a “tip credit” toward your federal minimum wage obligation.

The FLSA permits employers to take a maximum tip credit of $5.12 per hour. This means you can pay a tipped employee only $2.13 in direct hourly wages if that amount plus the employee’s tips equal at least $7.25 per hour.

If the employee works 2 jobs for your company, one tipped and other non-tipped, you can claim the tip credit only for the tipped position.

To be able to claim the FLSA tip credit, you must give the employee certain information in advance, either orally or in writing. This information includes the amount of direct wages you will pay the employee (i.e., no less than $2.13 per hour) and the amount of tip credit you will claim (i.e., a maximum of $5.12 per hour).

What is the state tipped minimum wage?

States have different rules pertaining to tipped employees, including the following:

• Many states have their own tipped minimum wage rates.
• Some states follow federal tipped minimum wage laws.
• Some states have their own definition for what constitutes a tipped employee, such as an employee who earns at least $20 (rather than $30) in tips per month.
• Most states permit employers to claim a tip credit, but the amount might be less than the federal tip credit.
• A few states prohibit employers from claiming the tip credit altogether. In such cases, employers must pay tipped employees the full state minimum wage.

Consult your state’s minimum wage laws to determine how they impact your tipped employees. Check local laws, as well, because some cities and counties have minimum wage laws for tipped employees. For example, the minimum wage for covered tipped employees in Flagstaff, Arizona as of 2021 is $12 per hour.

In general, when federal and state (or local) minimum wage laws apply, employers must use the law that’s most generous to the tipped employee.

In general, when federal and state (or local) minimum wage laws apply, employers must use the law that’s most generous to the tipped employee.

Who owns the tips?

The DOL says, “A tip is the sole property of the tipped employee regardless of whether the employer takes a tip credit.” 

You cannot require tipped employees to share their tips with employees who do not customarily receive tips — such as managers, supervisors, dishwashers, and cooks. However, under federal law, you can establish a valid tip-pooling arrangement and require tipped employees to participate.

In a tip pool, the employer collects a portion or all of the employees’ tips and divides it among participating tipped employees. Only employees who customarily receive tips can partake in the tip pool, such as servers, bartenders, and bellhops. Employers cannot take any of the pooled tips for themselves.

In a valid tip-pooling arrangement, employees cannot be required to contribute more of their tips than is reasonable or customary. According to the Texas Workforce Commission, the DOL will not question tip-pooling contributions that do not exceed 15% of the employee’s tips.

Make sure you check for tip-pooling laws in your state and locality because some states and localities ban tip-pooling entirely. Although some states and localities allow tip-pooling, they may have additional regulations that are stricter than federal law.

Are tipped employees eligible for overtime?

Tipped employees who are covered by the FLSA are nonexempt, which makes them eligible for overtime if they work more than 40 hours in a workweek.

The standard FLSA overtime calculation rate is 1.5 times the employee’s regular rate of pay. However, figuring overtime for tipped employees is a bit more in depth. To arrive at overtime pay for a tipped employee, you must first multiply the full minimum wage by 1.5. Then, minus the tip credit. The result is the hourly overtime rate, which is used to calculate the total overtime wages.

Example of FLSA overtime calculation for tipped employees

• Multiply the federal minimum wage by 1.5 to arrive at the general overtime rate ($7.25 x 1.5 = $10.88 per hour)
• Subtract the tip credit from the general overtime rate to arrive at the tipped overtime rate ($10.88 – $5.12 = $5.76 per hour)
• Multiply the tipped overtime rate by the overtime hours for the week to arrive at the total overtime wages ($5.76 x number of overtime hours)

The DOL’s FLSA Overtime Calculator Advisor provides concrete examples of overtime calculations for tipped employees under federal law.

Things can get complicated if your state has overtime or double-time laws that conflict with federal law. Another tricky scenario is when a tipped employee works different nonexempt roles that result in the need to calculate weighted average overtime — such as a tipped employee who works as a bartender and a waiter for the same restaurant. For situations like these, obtain clarification from a payroll expert or legal counsel if needed.

What are the payroll tax rules for tipped employees?

The Internal Revenue Service (IRS) has specific requirements for tipped employees and the employers that hire them.

Employee requirements

• Employees who earn $20 or more per month in cash tips must report their total tips to you by the 10th of the month following the month in which they received the tips.
• Maintain a daily record of all tips received. Employees can use IRS Form 4070A to record this information.
• Employees do not have to report tips of less than $20 per month to you, but they must report all tips received to the IRS when filing their federal tax return.

Employer requirements

• Keep a record of tips reported to you by tipped employees.
• Withhold federal income tax, Social Security tax, and Medicare tax from the employee’s wages and reported tips. Remit these withholdings to the IRS.
• Follow IRS guidelines on what to do if a tipped employee doesn’t have enough wages to cover the taxes owed.
• Pay your own (employer) share of Social Security and Medicare taxes, based on wages paid to tipped employees and tips reported to you.
• Include reported tips on the tipped employee’s Form W-2.
• File payroll tax reports, such as quarterly Form 941s and annual FUTA tax returns.

Most large food and beverage establishments must report gross receipts and tip earnings to the IRS via Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips. For more information on allocated tips, read “Reported, Unreported, and Allocated Tips.”

Along with following IRS payroll tax rules, you must adhere to applicable state and local payroll tax laws for tipped employees. These laws are established by the state and local revenue agencies.

FICA tip credit

The IRS offers a Federal Insurance Contributions Act (FICA) tip credit to eligible food and beverage establishments. These establishments can claim a credit for their Social Security and Medicare taxes paid or incurred on employee tips. To claim the FICA tip credit, file Form 8846 with the IRS.

In industries where tipping is customary, accuracy is vital to tax compliance. Be sure to educate your tipped employees on the importance of informing you about all reportable tips. In addition, you may want to consider participating in the IRS’ Tip Reporting Alternative Commitment (TRAC) program. TRAC is a voluntary program that promotes tip reporting compliance, such as through employee education. It also helps protect participating employers from certain IRS audits and penalties.