I frequently receive questions about tipping from small business or restaurant owners and employees. The purpose of this article is to provide initial answers to a couple of common questions. As always, this is not intended to be legal advice and context is everything. If you have questions specific to your situation you should consult with your tax preparer, accountant, or attorney.
What is a Tip?
A tip is a permissive payment made to a service provider from a customer. The customer retains the right to determine the tip and who the tip is paid to. By its nature, a tip is optional. This distinguishes true “tips” from “service charges” such as automatic/mandatory gratuities for large parties in restaurants.
Who Can Share a Tip?
A tip is the property of the employee who receives it. The Fair Labor Standards Act does not allow arrangements where part of the tip goes to the employer. That said, employees may voluntarily share tips with other employees. The rules unfortunately vary quite a bit amongst states depending upon whether a “tip credit” is given to employers. A tip credit allows an employer to pay a base rate of pay below minimum wage provided tips are sufficient to reach minimum wage.
Because Washington State does not have a tip credit the 9th Circuit, interpreting federal wage law, is fairly permissive when it comes to who can share in a “tip-pool”. (See Cumbie v. Woody Woo, Inc., 596 F. 3d 577 and the Department of Labor has agreed. http://www.dol.gov/whd/FieldBulletins/fab2012_2.htm). Be wary relying on these opinions in regards to tip-pooling because this issue appears unsettled.
Tip-pools in general may only include employees who “regularly and customarily” receive tips, such as waiters and bartenders. However, in Washington State the tip pool can likely be shared with many other employees unless those employees include managerial staff (see above). Regardless, there are three (3) general criteria for a tip pool:
- Only non-management employees can participate in tip pooling or tip sharing.
Like all rules this statement breaks down somewhat depending upon the circumstances and nature of the position in question. For example, see: http://www.usatoday.com/story/money/business/2013/06/26/ny-court-starbucks-baristas-must-share-tips/2459851/. (Starbucks Shift-Supervisors allowed to share tips, but Assistant Managers denied);
- The tips are distributed among the pool participants in a fair and reasonable manner, proportional to the degree they served the customer; and
- Pooling tips for redistribution is not required of employees.
Who Should Report Tips?
EVERYONE – both Employers and Employees. Any employee who makes even a small amount of tips in a month, currently more than $20, should report those tips to their employer. The employer is then required to report FICA (Federal Insurance Contributions Act) and determine appropriate taxes. However, accountability still falls back to the employee because the employer cannot pay its share of FICA taxes if the employee fails to report tips.
What is the Correct Way to Handle Automatic Gratuity?
Automatic gratuities are considered “service charges”, as opposed to tips. This service charge falls outside of the definition of a tip when it is mandatory. Though it may still be passed through to the service provider, an employer needs to be wary of how such service charges are calculated for taxing purposes (as wages instead of tips). Additional reporting requirements may be required. For an excellent summary of this issue along with more national concerns, I highly encourage the reader who wants to know more to review the following article: http://www.law360.com/articles/532470/tips-and-service-charges-how-to-stay-compliant. It is worth registering for an account.
Are there Unique Considerations for Washington State and Seattle?
Washington State varies from many other states when it comes to tipping and wages. We have one of the highest minimum wages in the country, currently at $9.32 per hour and rising to $9.47 on January 1, 2015.
Unlike most other states, Washington State employers do not get a “tip credit” in the payment of wages to their employees. As mentioned above, “tip credits” can change the dynamic of tipping and “tip-pooling”. This lack of a “tip credit” may keep things relatively simple in Washington State, but will this change how wages are calculates as the minimum wage continues to increase?
Does Seattle’s Minimum Wage Law Change How Wages Are Calculated?
Maybe. A new twist to tipping comes from Seattle’s recent minimum wage ordinance. See http://murray.seattle.gov/minimumwage/#sthash.8NNGCl0V.dpbs. The new wage law warrants a complete blog post of its own, but in context of tipping, it has at least one potential twist. The law allows smaller employers to meet a certain portion of the minimum “compensation” requirements through tips, commissions, medical benefits, etc. This sounds a lot like a tip-credit. If it is considered a tip-credit by the IRS, there may be concerns here with tip-pooling amongst staff and wage taxing and calculations for tax reporting.
Though the new Seattle minimum wage is easy enough to follow for Seattle employers, I could see confusion ensuing for calculation of other taxes, FICA, or overtime compensation. These laws do not start phasing in until April 1, 2015, leaving plenty of time to clarify payment and wage practices with your accountant, tax professional, or attorney.