For as long as most people can remember, service employees in restaurants, bars, etc. have relied on tips from customers as a supplement to their income, or in many cases, as the principal source of their income. Recognizing this fact, the federal wage and hour law, the Fair Labor Standards Act of 1938 (“FLSA”), allows employers of servers and certain other employees to be paid cash wages at rates less than the FLSA minimum wage, and to make up the rest of the minimum in tips. Currently, the minimum wage is $7.25. Tipped employees who meet a few basic requirements can be paid as little as $2.13 per hour in wages, and the remaining $5.12 needed to bring them up to $7.25 can come from their tips. This is called a tip credit. To qualify for tip credit, employees have to be informed by their employer as to how they are to be paid, must be engaged in customer contact jobs, like servers or bartenders, and must customarily and regularly receive at least $30 per month in tips. And of course, they have to make enough in tips to bring them up to the minimum wage — at least.

There is an additional requirement, however. Section 6 of the FLSA says in part that tip credit “… shall not apply with respect to any tipped employee unless…all tips received by such employee have been retained by the employee, except that this subsection shall not be construed to prohibit the pooling of tips among employees who customarily and regularly receive tips.”

See 29 USC 203(m).

Tip Credit, Tip Pools, and Retroactive Penalties

Employers cannot claim tip credit for their serving employees unless those employees keep all their tips. The employer cannot take employees’ tips or control their disposition in any way, with the sole exception that tipped employees can be required to contribute to a tip pool. Moreover, the tip pool can only include other serving employees, not “back-of-the-house” employees like cooks and dishwashers, and certainly not managers. If servers are required to pay into a tip pool that includes ineligible employees like cooks, the consequences are severe. The employer must not only reimburse the servers the amounts they contributed to the tip pool, but also loses the tip credit retroactively. This means that in an investigation by the US Department of Labor (“DOL”), Wage and Hour Division (“Wage Hour”), which enforces the FLSA, or in litigation — a restaurant could have to pay its servers back wages of $5.12 per hour for each hour worked in the previous two years.  (That’s the general statute of limitations in the FLSA. If the violations were willful, the statute of limitations is extended to three years).

This position is clearly based on the plain wording of the statute — if you want to claim a tip credit, you have to allow employees to keep their tips. But, what happens if employers decide to pay tipped employees the full minimum wage, and claim no tip credit? This happens more often than you might think. One big reason is that several states with minimum wage laws don’t allow tip credit. They are California, Oregon, Washington, Nevada, Montana, Minnesota and Alaska. But even in the states which do allow tip credit, some employers choose not to use it.

Tips are Property of the Employee

Even when employers don’t claim a tip credit, however, it has been Wage Hour’s long-standing enforcement position that tips are the property of the employees to whom they are given, and the employer may not take them or control their disposition. Even today, Wage Hour’s regulation on wage payments states: “Tips are the property of the employee whether or not the employer has taken a tip credit under section 3(m) of the FLSA. The employer is prohibited from using an employee's tips, whether or not it has taken a tip credit….” See 29 CFR 531.52. The Wage Hour Field Operations Handbook (“FOH”), which contains the agency’s interpretations and enforcement positions, says:

A tip is a sum presented by a customer to the tipped employee as a gift or gratuity in recognition of some service performed for him or her. See 29 CFR 531.52. The only ways in which an employer may use its employee’s tips are through a valid tip pool, as defined in FOH 30d04, or as a partial wage credit. See FOH 30d00(d) and FOH 32j18(h). These restrictions on an employer’s use of its employees’ tips apply even when the employer has not taken a tip credit; in such a case, the employer may only use its employee’s tips in furtherance of a valid tip pool.

See FOH 30d00(e)(2) (emphasis added).

This has been Wage Hour’s position since at least 1974. It should be clear, however, that Wage Hour’s position did not comport with the plain text of the statute. The statute said that tip retention was a condition of claiming the tip credit. The agency asserted that tip retention was mandated whether or not an employer claimed the tip credit.

Thus, the Wage Hour enforcement position was rejected in 2010 by the Ninth Circuit Court of Appeals, which held:

However, we cannot reconcile this interpretation [i.e., Wage Hour’s position] with the plain text of the third sentence [of that part of 29 USC 203(m)], which imposes conditions on taking a tip credit and does not state freestanding requirements pertaining to all tipped employees. A statute that provides that a person must do X in order to achieve Y does not mandate that a person must do X, period.

Cumbie v. Woody Woo, Inc., 596 F.3d 577, 581 (9th Cir. 2010) (hereinafter referred to as “Woody Woo”).

In spite of this case, when DOL updated its regulations effective April 5, 2011, they explicitly rejected the Ninth Circuit’s findings and reiterated their position that tips belong to the employees to whom they are given, whether or not the employer claims a tip credit. The same issue was raised again in the Ninth Circuit in Oregon Restaurant and Lodging Association (ORLA) v. Perez, 816 F.3d 1080, 1090 (9th Cir. 2016). The Court held:

In deciding ORLA, the Ninth Circuit concluded that Woody Woo held only that section 3(m) does not prohibit employers that do not take a tip credit from instituting an invalid tip pool. See id. at 1088. Having found that the FLSA is silent with respect to employers that do not take a tip credit, the Ninth Circuit concluded that the 2011 tip regulations were a reasonable application of the agency's authority to fill gaps left by the text of the FLSA….

See 82 FR 57395, 57397 – 57398 (December 5, 2017). In other words, ORLA effectively overruled Woody Woo by saying that the April 5, 2011 regulatory update justified Wage Hour’s position.

There were, nonetheless, several subsequent cases that called Wage Hour’s position into question, e.g., Marlow v. New Food Guy, Inc., 861 F.3d 1157 (10th Cir. 2017). It is against this background that the DOL proposed significant changes in their previous positions. On December 5, 2017, the DOL issued a Notice of Proposed Rulemaking, that would change 29 CFR 531 substantially:

The Department proposes to remove or amend the portions of §§ 531.52, 531.54, and 531.59 that impose restrictions on employers that pay a direct cash wage of least the Federal minimum wage and do not claim the section 3(m) tip credit. The proposed rule deletes the fourth sentence of section 531.52, which currently states that “[t]ips are the property of the employee whether or not the employer has taken a tip credit under section 3(m) of the FLSA.” The proposed rule also revises the fifth sentence of sections 531.52, the last sentence of section 531.54, and the final sentence of section 531.59(b) to remove language placing restrictions on an employer's use of tips when that employer has not taken a tip credit while retaining language that reflects the statutory restrictions on an employer's use of tips received by its employees when it does take a tip credit.

See 82 FR 57413 (December 5, 2017).

Opposition to Proposed Changes

As might be expected, the proposed changes have resulted in a lot of opposition. For example, Heidi Shierholz, who was chief economist at the DOL under President Barack Obama, concluded that the rule change could cost workers billions, as employers will likely fail to redistribute the money as proposed. "We believe employers will pocket between $523 million and $13.2 billion in workers’ tips annually, with $5.8 billion being our best estimate…." (Newsweek, 2/5/18). In the same article, Newsweek cited a Bloomberg report that claimed that “…senior officials at the Labor Department apparently withheld studies showing that workers could lose billions under this plan and that restaurant managers and owners would likely benefit from the rule change.” Id.

Tip Income Protection Act of 2018

Then Congress stepped in. A part of the 2300 page budget bill just enacted was the “Tip Income Protection Act of 2018.” This provision states,“ Any employer may not keep tips received by its employees for any purpose, including allowing managers or supervisors to keep any portion of employees’ tips, regardless of whether or not the employer takes a tip credit.” So, the “employer” may not keep tips, and that includes managers or supervisors.

So where are we? Any part of the proposed rule that is inconsistent with the Tip Income Protection Act of 2018 is, of course, null and void. It appears that where employers don’t take a tip credit, Wage Hour’s proposed change of position — allowing back-of-the-house employees to participate in tip pools — can survive. But, it’s clear that managers at any level cannot participate in tip pools. New regulations consistent with the statutory changes can be expected.

It’s important to note that for employers of tipped employees who do take tip credit, nothing has changed. Tipped employees must still retain all of their tips, subject only to the exception that they can be made to contribute to a tip pool. That tip pool can only include other serving employees, however, like bartenders, bussers, seater-greeters, etc. Managers and back-of-the-house employees cannot participate in the pool.

By Published On: May 2, 2018Categories: Employment LawTags:


Avatar of Brian Farrington
Brian T. Farrington is a Shareholder and Section Head of the Cowles and Thompson Employment Law section. His practice consists of transactional work and litigation advising and representing management concerning employment law, and particularly in the areas of Fair Labor Standards Act and Equal Employment Opportunity laws. He consults with employers to assist them in compliance and to represent them in investigations by the U.S. Department of Labor, Wage and Hour Division. Brian also advises clients on compliance with state wage and hour laws and represents them in investigations by state Departments of Labor. He also advises on matters related to Texas Workforce Commission unemployment eligibility, government contracts labor standards (Davis Bacon Act, Service Contract Act), OSHA 11(c), and state wage payment laws. Brian has represented clients in litigation under the FLSA, Title VII, the ADEA, and the ADA. Prior to becoming an attorney, Brian spent 12 years working with the US Department of Labor Wage & Hour Division. He has served as an Expert Witness in FLSA employment matters, and is a trained employment-related mediator.