Restaurant Tip Pooling Laws & Guidelines

Tip pooling is combining all or a portion of all of your employees’ tips and redistributing among eligible front-of-house employees. Often confused with tip sharing, which traditionally includes employees who don’t directly receive tips, tip pooling can increase morale. However, there are laws, like forbidden management participation, that must be followed to avoid being fined.

If you need a way to report and pay cash and credit card tips to employees who pool their tips, consider Gusto. Once you determine how much to allocate among employees and enter into the software, taxes will be withheld (and filed) and direct deposits processed.

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How Tip Pooling Works

Tip pooling can be handled in multiple ways. Generally, tipped employees collect all of the cash tips they receive throughout their shift and combine them with tips from each participating employee working the same shift. Once tips are totaled, the employer or employees divide them evenly among tip pool participants. Tips received by credit or debit card can be distributed in a similar fashion the same night (if enough cash is on hand) or paid with the next payroll.

Recently, the Wage and Hour Division of the Department of Labor (DOL) overhauled a 2011 regulation that disallowed back-of-house (BOH) employees, like cooks and dishwashers, to participate in tip pools. As long as you’re paying all of your employees at least the federal minimum wage rate of $7.25 an hour, you can include BOH employees in your tip pooling policy.

Typically, when pooling tips includes BOH employees, it isn’t an even divide. Allocations are generally based on a percentage of sales or a percentage by job title. Usually, servers receive the bulk, at least 70%, but it can be under 50%. A sample tip pooling arrangement by percentages is as follows:

70% for servers
12% for the runner
10% for the busser
8% for bar staff

Employers are encouraged to use their discretion when establishing tip pools. There’s no official guidance regarding how much servers should have to pay out, but it’s a good idea to have some sort of methodology behind your allocation. If your employees create a tip pool on their own, they can decide how much to redistribute and who they want to share it with.

Types of Tips for Tip Pooling

To understand tip pooling, you must have a firm grasp of what a tip is. Per the IRS, a tip is a voluntary amount of money left by a customer to pay workers for their service. It’s money paid in addition to regular wages and is taxable if it exceeds $20 monthly. Customers can leave tips via cash, check, or credit card. However, if you add a required service charge to their order, you cannot treat them as tips.

Cash

Although electronic payment methods continue to dominate in business, some customers still pay cash tips. When your employees receive cash tips, the money is pooled and divided after the shift, and they typically take them home the same night. There have been cases in which employers have held the cash to distribute at the end of the week or with the next payroll, but due to the changing payroll compliance laws for tip pooling, you should seek legal counsel before doing so.

Debit or Credit Card

Because they’re so easy to use and many customers don’t carry cash, debit and credit card tips are on the rise. When your employees receive tips per electronic transactions, you can hold, pool, divide, and pay them out with their paychecks. The best payroll software includes tip reporting to make it easy for you to track taxable tips, too.

You can also choose to perform the redistribution calculations at the end of each shift and distribute them in cash, if you have enough on hand. This can be time-consuming, so you should evaluate your schedule before implementing.

If you’re charged a fee to process the debit or credit card tips, federal law allows you to deduct them from the tips you distribute. Check your state’s law before implementing to ensure there’s no policy to restrict you from doing this legally. For instance, if you’re in California, you’re prohibited from deducting credit card fees from employee tips.

Check

If your restaurant still accepts check payments (some don’t), some customers may choose to pay tips that way. Similar to how you handle electronic payments, you have the option of pooling the tips and paying them in cash at the end of each shift or waiting until you cash the check and paying out with payroll. You could also cash the checks prior to processing payroll and pay out in cash before the next payday.

Service Charges

Service charges are automatic gratuities, usually based on a percentage of the total bill, that customers are required to pay. Some high-end restaurants charge all of their customers service charges, while others only charge them to large parties (for example, 20% for a party of more than eight people).

Because service charges are required, they aren’t considered tips, even if you pay a portion or all of them to employees. You can divide the tips among employees however you wish, but it’s not considered tip pooling. Service charges must ultimately be reported as income to the business, and any gratuities you pay out to employees are wages.

Directly Tipped vs Indirectly or Non-tipped Employees

Directly tipped employees are employees who are regularly and customarily tipped at least $30 monthly (service charges paid to employees aren’t included). Traditionally, these are the employees (e.g., servers, hosts, and bartenders) who have participated in tip pooling arrangements. Per new guidance from the DOL, restaurateurs who pay all employees at least minimum wage can include non-tipped employees, like cooks and dishwashers, in a tip pool. Many states still don’t allow it, so check with your state DOL.

Tip Pooling vs Tip Sharing

Prior to federal law changes made in March 2018, the lines between tip pooling and tip sharing were clear. Although many mistakenly used them interchangeably, tip sharing is a practice in which tipped employees share some of their tips with BOH employees. It used to be illegal for many restaurants to require this type of distribution when pooling tips, but restaurateurs often encouraged their servers to do so at their own discretion. Tip pooling traditionally only includes front-of-house (FOH) employees.

Per federal law today, restaurateurs who pay at least minimum wage can mandate that BOH employees are compensated from pooling arrangements. This blurs the line between tip pooling and sharing on a federal level. The DOL’s guidance states, “Employers who pay the full Federal Labor Standards Act (FLSA) minimum wage are no longer prohibited from allowing employees who are not customarily and regularly tipped—such as cooks and dishwashers—to participate in tip pools,” and doesn’t differentiate between the two.

Many states have laws that still don’t allow establishments to mandate tipped employees share tips with BOH employees, which makes it less confusing to understand the difference between tip pooling and tip sharing. It’s also important to note that for pooling to occur, all or a portion of employee tips must be added together before distribution. Traditionally, many servers who shared tips with BOH employees did so out of their own individual tips, meaning they didn’t pool them.

It helps to understand the differences between, and the history of, tip pooling and tip sharing so you’re not confused as new federal and state legislation is passed.

Employees Who Participate in Tip Pooling

When setting a tip pooling policy for your restaurant, you need to know the positions you can include (and those you have to exclude). Federal law allows them all (if you’re paying each employee at least the federal minimum wage) with the exception of restaurant owners, managers, and supervisors.

Here’s a table to help you understand who you can mandate to participate in a tip pool per federal law:

Tip Pooling: Employees to Include per Federal Law

Tip Pooling Laws

Although the federal government changed the rules for tip pooling, many states have yet to do so. However, states with pre-existing laws that disallow paying tipped employees below minimum wage, including Alaska, California, Minnesota, Montana, Nevada, Oregon, and Washington, were automatically granted permission to include BOH employees in their tip pooling arrangements. This is because all staff within the establishment were already earning at least minimum wage, which is a requirement for restaurateurs who want tips shared with non-tipped staff.

Federal Tip Pooling Laws

Aside from who can participate in a tip pool, the DOL has other regulations you need to be aware of to protect you from liability. It’s important to remember that all tips (not service charges) belong to your employees. Even when paid to your restaurant through a credit or debit card transaction, you’re prohibited from keeping any of the tips for yourself or your business. You’re also not allowed to pool and distribute them to any employees in a supervisory position.

Here are some hard and fast rules in regards to pooling tips:

• Notify employees: You must notify tipped employees of any required tip pool contribution amounts as well as to whom they will be redistributed prior to their participation. It’s a good idea to have a standard notice on hand to provide upon hiring.
• Don’t keep tips for the business or yourself: Employers are prohibited from retaining employees’ tips for any purpose other than verifying or processing with their next paycheck. All tips are the property of the employees.
• Don’t include managers and supervisors: Managers and supervisors are not allowed to participate in a tip pool under any circumstances.
• Don’t include BOH employees if you pay under minimum wage: If you pay your servers below minimum wage, meaning you claim a tip credit (credit you receive as long as employees earn enough to keep their wages above minimum wage), you cannot include BOH employees in a required tip pooling arrangement.
• Require reasonable contribution amount: You can’t require employees to pay more into the tip pool than is customary and reasonable. In 2011, the DOL initially defined this as 15% of tips received or 2% of daily sales, but there are no hard rules as it hasn’t yet established a maximum contribution amount. Many restaurant employees pay above 15%.

State Tip Pooling Laws

We’ve mentioned it several times already, but just to reiterate, tip pooling laws vary widely by state. California and Arizona allow you to add BOH and front-of-house (FOH) employees to a tip pool, but Minnesota outlaws it altogether. New York State only allows FOH employees to participate, stating that eligible employees “must perform, or assist in performing personal service to patrons at a level that is a principal and regular part of their duties and is not merely occasional or incidental” and that only “food service workers may receive distributions from the tip pool.”

Oregon and many other states don’t have specific regulations for pooling tips, which means employers can include BOH employees in the tip pool. Some states, like Washington, took a lead and established a policy to give employers much needed guidance. Washington State’s latest policy mentions that the state law doesn’t specify which employees may be included in a tip pool, with the exception that those who don’t meet the definition of an employee cannot participate.

Tip Reporting

If your employees receive more than $20 per month in tips, the IRS requires that you report it as taxable income, which means you need to establish a solid tip reporting system to ensure nothing is excluded. As the employer, you must collect, pay, and remit payroll taxes on all reported tips.

You can provide your employees with Form 4070 to use when reporting the tips they receive each month, including cash, check, and credit card tips. In regard to tip pools, employees should only report and pay taxes on the tips they keep. Don’t withhold taxes on tips they received but redistributed.

Tracking tips can be cumbersome, especially when you have to divide them among other employees. Provide your team with Form 4070A; it’s a workbook that will help them track their tips on a day-to-day basis. As you review, ensure the total tip income they report each period is at least 8% of their total gross sales for the same period; otherwise, if you have more than 10 employees, you may have to pay them additional money in the form of allocated tips.

Service Charges

Don’t include mandatory service charges in any tip allocations. Service charges are income to the business, even if they’re distributed later to employees. Your business must pay taxes on the service income, and what you distribute to employees is considered a wage expense.

Consequences of Not Complying With Tip Pooling Laws

Common violations employers make in regard to tip pooling regulations are including ineligible employees in a required tip pool and not paying employees all tips received. Per the DOL, if you violate any federal tip pooling laws, you’ll have to pay the employees back for any tips they were owed but didn’t receive, tip credits claimed, and an additional amount for liquidated damages.

And you’re not allowed to force employees who shouldn’t have been in the tip pool (for instance, BOH employees) to return any tips wrongly paid to them; you’ll have to pay with your own money. It’s also important for you to be aware that if you violate tip pooling laws at the state level in addition to federal, you’ll likely owe additional penalties.

If you need a way to track sales and tips so you can avoid costly fines, consider Lightspeed Restaurant. It provides an easy way for your employees to clock in and out, take orders, and track tips. It also integrates with time scheduling software HomeBase and payroll software Gusto to help you streamline your payroll process. Pooled tips can be tracked, reported, taxed, and paid seamlessly. Call Lightspeed for a free quote today.

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Pros & Cons of Tip Pooling

Tip pooling has both pros and cons. On the one hand, it allows more employees to feel adequately compensated for their part in providing service, potentially increasing morale. On the other hand, some employees don’t believe it’s fair; their view is the customers paid the tip to them, not other servers or BOH employees.

Pros of Tip Pooling

Here’s a list of the pros of tip pooling:

• Fosters teamwork: When tips are pooled, all participating employees are working toward a shared goal, which encourages teamwork. Because one person’s actions can affect the total tips received, staff members are more likely to support and help one another be their best.
• Reduces income inequality: BOH employees are usually paid a flat hourly rate with no opportunity to earn extra money. With FOH employees sharing their pooled tips with them, overall earnings within the restaurant should have less disparity.
• Reduces conflict over tables: Some servers become disgruntled when a host(ess) doesn’t assign them a particular table, usually when the server suspects the customers at said table will pay a large tip. Tip pooling requires employees to put their tips together, so no one will receive a large individual sum.

Cons of Tip Pooling

Here’s a list of the pros of tip pooling:

• Build resentment among high-performing servers: Servers who regularly receive a large amount of tips may be unhappy about sharing their earnings with lower performers. They may feel that they’re being cheated out of money they earned.
• Service quality may drop: When employees are working for their own individual tips, they’re more likely to provide greater service because the total tips they receive depends on it. Participating in a tip pool removes the pressure.
• Low performers are rewarded: Employees who don’t work as hard are rewarded for effort they don’t put forth, because a tip pool arrangement isn’t based on quality of work.

Best Practices for Establishing a Tip Pooling Policy

If you’re implementing a mandatory tip pooling arrangement in which employees are required to participate, establishing a policy is essential. You should document your policy and make updates when necessary, such as when new tip pooling laws are implemented. Be clear and concise to prevent confusion. You want your employees to understand how much they’re required to contribute and to whom. To ensure you’re complying with federal and state tip pooling laws, consider speaking with a lawyer first.

“The top tip pooling laws restaurateurs should keep in mind are that tips cannot form part of an employee’s wage to make it up to the national minimum wage. Employees must be paid at least the national minimum wage, and tips are received in addition to this.

“The other important law to remember is that tax must be paid on all tips. This may help you decide how to form your business’ tip policy. For example, if you operate a shared tip system among staff, the staff are responsible for declaring tips to PAYE, and you may have a troncmaster who represents the staff in this.

“Alternatively, if the business processes the tips through their till system, they will be responsible for declaring and paying tax on each person’s tip share. Some businesses will keep a ‘handling’ percentage of the tips. Whichever way tips are processed, the policy must be transparent to all employees and customers alike. “

– Sarah Taylor, Consultant, High Speed Training

Alternatives to Mandatory Tip Pooling

To avoid the legal complexities associated with mandatory tip pooling as well as some of the disadvantages, you should consider alternatives. First, determine why you want to implement a mandatory policy. Common reasons are to raise wages for BOH employees, ensure all tipped employees receive compensation for their service regardless of how well their customers tipped, and reduce bickering over certain customers.

Here are some alternatives to mandatory tip pooling that you should consider:

Increase Wages for Back-of-House Employees

If your goal is to even the income disparity between FOH staff, like servers, and BOH staff, consider regularly increasing hourly wages for BOH employees. The pain point BOH employees feel is that their wages don’t fluctuate, which means they don’t rise like that of tipped employees. If you offer performance raises or bonuses, BOH employees are more apt to retain their motivation.

If you’re worried about how regular wage increases will affect your bottom line, consider taking advantage of the tip credit. Per federal law, you can pay tipped employees an hourly wage as low as $2.13 an hour as long as they receive enough tips (individually and in a valid tip pooling arrangement) to earn the $7.25 hourly minimum wage rate.

Just keep in mind that if you opt for the tip credit, you can’t revert back to requiring FOH employees to pool or share tips with BOH employees; it must be optional.

Educate Employees On & Encourage Voluntary Tip Pooling

Mandatory tip pooling means you require your employees pay their tips into a pool to be redistributed. Voluntary tip pooling is similar but is organized completely by the staff. They may ask you if you will help facilitate by distributing through payroll or counting and paying it out in cash, like you would automatically do if it was mandatory, and it’s your decision as to whether you’re willing to do so.

For this setup to be voluntary, you cannot have any say-so in how tips are collected or redistributed. When it comes to tips received electronically and by check, you have a say in how quickly you will pay them out (albeit the upcoming pay period is the latest you’re allowed to pay), because the tips are paid to your restaurant. You still don’t get to decide who gets what or how much.

In this scenario, you can still participate in the tip credit and possibly be assured your BOH staff receives tips, if employees decide to include them. The key to establishing a legal voluntary tip pooling arrangement is to ensure it’s adequately reflected that you didn’t coerce or force employees into the agreement. You could request that they sign a document to verify that their decision to establish a tip pooling arrangement was independent of you.

Frequently Asked Questions (FAQs) About Tip Pooling

In this article, we discussed the different tip pooling laws and regulations. However, we realize that some questions are asked more frequently than others, and we’ve addressed them here.

What is tip pooling?

Tip pooling is the practice of contributing all or a portion of tips received into one big pool that’s later divided among a group of employees. Pooled tips can be redistributed in numerous ways, including by hours worked, sales, and percentages based on job title.

What are the new tip pooling laws?

The new federal tip pooling laws allow BOH employees to participate in tip pools along with FOH employees as long as employers are paying everyone at least the federal minimum wage rate of $7.25 an hour. Another rule is that neither managers nor anyone in a supervisory role can participate in a tip pool; tips are the property of employees. State tip pooling laws differ on whether or not BOH employees can be included.

Is tip pooling legal?

On a federal level, yes, tip pooling is legal. When it comes to state law, it depends on the state. California and New York both allow tip pooling, although governed by different regulations, but Minnesota doesn’t allow it at all. When there’s a conflict between federal and state law, always choose the one that gives employees the most protection. Generally, as long as state law is similarly or more restrictive than federal, you can opt to follow state rules.

Bottom Line

Tip pooling laws can be confusing due to the new federal amendment allowing back-of-house employees to participate and the various state laws that allow, prohibit, are unclear, or don’t express an opinion on the matter. Ensuring you follow all rules may require a legal adviser; otherwise, you can be charged thousands of dollars for violations.

Because employees who participate in tip pools are required to report their tips, consider using Gusto to keep track. You have the option of paying out tips in cash or adding them to employee paychecks. However you decide to handle employee tips, taxes are withheld, filed, and paid automatically. Sign up for a free 30-day trial today.

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