“Tip out” is a restaurant practice where staff members who collect tips distribute a portion of those tips to their co-workers.
What Is a Tip Out? A Complete Guide to Restaurant Tipping Methods
With more than a decade of hospitality experience, Mary has worked in some of the most celebrated restaurants in the world. Her expertise is featured across Fit Small Business in restaurant, retail, and starting a business content.
Tip out is the term restaurant workers use to describe the act of distributing tips from one tipped employee to another. It is a necessary part of restaurant operations because only some tipped workers can process payments and, thereby, collect the tips. In a tip-out arrangement, servers and bartenders generally collect the tips and distribute them to other tipped workers like bussers, barbacks, and—depending on local labor laws—kitchen staff.
Managing tip outs is a regular part of restaurant management. By the letter of the law, tips belong to the employee they were given to. But employers can establish a tip-sharing policy as a condition of employment. Requiring tipped staff to share tips is not illegal, but there are tipping laws employers must follow. There are several ways to arrange your tip-sharing policy. What works best will depend on your staff configuration, service style, and sales volume.
Tip Out vs Tip Pool: Is There a Difference?
There are two basic types of tip shares in restaurants: tip out and tip pooling. The only difference between a tip out and tip pool is how the tips are gathered and distributed.
- In a traditional tip out, staff that collect tips from customers give a portion of their tips to the other staff members that helped them, like the busser who cleared and reset their tables. This may be a voluntary choice from the server or—more frequently—a mandated amount set by the restaurant.
- In a tip pool, all the tips collected by the staff in a single shift are pooled together. Pooled tips are then distributed to all tipped workers based on a set formula of points or percentages based on their role.
Pooled house: Restaurants with a tip pool are frequently called “pooled houses.” You’ll hear this frequently when interviewing front-of-house workers (i.e., “is this a pooled house?”). Some staff prefer pooled houses, while others prefer a tip-out structure.
See our tip-out alternatives section for more on tip pooling.
Tip-out Types
There are two major types of tip out: tip out as a percentage of tips and tip out as a percentage of sales. They are both pretty straightforward. Click through the tabs below to see a full description of each tip-out type, along with its benefits and drawbacks.
A note on bartenders: They are typically the only workers in a tip out system that both give and receive tips outs. Just like servers, bartenders open and close checks, but they also support the servers by making their drinks.
Tip-out Costs
There is more to consider about tip outs than the size of everyone’s portion. Any business that handles or distributes gratuities will incur related costs. Beyond the standard payroll taxes, credit card processing fees are associated with credit card tips. The more detailed your tip structure, the more managerial time you will need to spend overseeing it.
These are a few tip-out costs that a restaurant owner should be prepared for:
- Credit card processing fees: Some 70%–80% of your customers will tip with a credit card. Like the rest of your credit card payments, your business will incur a 3%–4% processing fee from your merchant services provider. Some states permit restaurant owners to retain this amount from employee tips. Your local department of labor website will provide accurate information about city or state guidelines.
- Payroll taxes: If tipped employees earn more than $20 per month in tips, employers are obligated to withhold Social Security, Medicare, and income taxes from the reported tips, as well as pay the employer’s portion of Federal Unemployment Tax (FUTA) and Federal Insurance Contribution (FICA) on reported tips. If you turn over service charges or auto gratuities to your employee tip pool, you’ll also need to pay payroll taxes on those monies just as you would with regular, hourly wages.
- Employee complaints: Restaurants from TGI Fridays to high-end restaurants like Per Se have been sued by employees alleging wage theft due to misallocation of tips. A complaint doesn’t need to reach the level of a lawsuit to cost a restaurant owner money. An employee complaint to the Wage and Hour Division of the Department of Labor can spur an investigation into your payroll records. Any errors they find can result in fines.
Managers and owners also must ensure that tips are accurately recorded for your payroll processor so the correct amount of withholding can be applied. Restaurants that pay out all tips in cash at the end of shift should also consider the administrative time necessary to arrange change orders and make trips to the bank to replenish the cash supply.
Tip-out Pros & Cons
There are almost as many ways to compensate service staff as there are types of restaurants. In fact, some restaurants choose not to permit tipping at all. What works for one business may not be the best solution for another, so it is important to consider all the pros and cons before choosing a direction for your business.
| PROS | CONS |
|---|---|
| Spread the wealth: Sharing or pooling tips across the staff makes the compensation more equitable across a restaurant, which usually increases teamwork and staff morale. | Over-competition can impede service: Unregulated tip outs can lead to “deals” among the service staff, negatively impacting the guest experience. If one server has agreed to pay the host more in tip out than another server to ensure she seats the best tables in his station, that server could easily get overwhelmed while his co-workers are left with nothing to do and no incentive to help. |
| Create performance incentives: When all of the service staff earn a portion of tips, they are incentivized to help increase sales and provide a high level of customer service. | Staff can feel unequal: Even with the most thoughtfully designed tip-out system, some staff members can feel disgruntled that other roles are offered more points in a pool or a higher percentage of tips. |
| Familiar to employees: Most seasoned restaurant teams are already familiar with receiving tips, pooling tips, and tipping out colleagues. It is a relatively transparent system that lets the staff directly see compensation for their efforts. | Record keeping takes time: Designing and enforcing a tip pool takes time daily. The more complicated the tip-out or pooling arrangement, the more time it can take. It is worthwhile for restaurant owners and managers to consider whether this is time well spent or if their skills are more valuable when performing other tasks. |
Tip-out Alternatives
An alternative to traditional tip out is tip pooling. Tip pools are a slightly more complicated form of tipping out. In the case of a pool, all the tips customers give in a single service are combined into one pot. The pooled tips are then distributed to service staff based on a predetermined formula. The same laws apply tip pools as tip outs, though some states prohibit tip pooling. So check your local labor laws before deciding on a tip-sharing strategy.
Pools based on the hours worked are popular in quick-service restaurants, while pools based on “points” make more sense in full-service. Some restaurants with a large staff prefer a pool based on points and hours. Click through the tabs below for a full explanation of each.
Hours-based Pool
This is the simplest tip pool arrangement. You can run this kind of tip pool for a single day, a single shift, or even for a whole week or whole pay period, depending on your service style.
It looks like: | Example: | Use it when: |
|---|---|---|
All tip-collecting staff add their tips to a collective tip pool. All tip-receiving staff are given tips based on the number of hours they worked. | In a coffee shop, the credit card tips and cash tips from the tip jar from a single week are gathered. They total $400. The tipped workers collectively worked a total of 100 hours. Each hour worked is worth $4. A barista who worked 10 hours for the week receives $40. A barista who worked 20 hours receives $80. |
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The biggest downside is that this type of pool does not reward high selling as much as other pool types. But it definitely encourages teamwork, and is pretty simple to manage.
Points-based Pool
A tip pool based on points begins with assigning a number to each service position based on its level of responsibility. This number becomes that staff member’s “points in the pool.” Typically, servers and bartenders are assigned the highest number of points because of their level of interaction with the guests and their unique position to increase sales.
It looks like: | Example: | Use it when: |
|---|---|---|
In a restaurant’s tip-sharing policy, front-of-house positions are awarded the following points:
At the end of a shift, all the tips from all the servers and bartenders are added together. Then, all the points for all staff that worked that shift are also added together. | On a shift with two servers, one bartender, one busser, one barback, one food runner, and two hosts, the points would add up like this:
Total points: 50 If the team above was splitting a pool of $500 in tips, then each point would be worth $10 ($500 / 50). And the tips would break down this way:
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A points-based pool can start to take up a lot of administrative bandwidth. When you get to this level of detail, a point-of-sale (POS) or app-based tip allocation tool can really pay off.
Points & Hours Pool
This system is the most complicated, but many restaurants find it the most flexible. A points-and-hours system allows managers to cut staff when business slows while still honoring everyone’s contribution when the tips are allocated at the end of the shift.
It looks like: | Example: | Use it when: |
|---|---|---|
A points-and-hours tip pool begins just like the points system, assigning a number of points to each service position based on its level of responsibility. Then, figure each employee’s total points for the shift by multiplying their hours worked by their role-based points. | Let's take the same staff configuration as the points-based pool and say half the team worked an 8-hour shift, except for one server and one host who worked half that. The points would break down like this:
Total points: 352 If the pool brought in $500 in tips, a point would be worth $1.42. And the breakdown would be:
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The biggest drawback to a points-and-hours pool is its complexity. I can tell you from experience that it takes a lot of administrative bandwidth to manage a points-and-hours tip pool—though you can shift some of this work onto the staff or use a POS that manages it for you. And in most locations, you’ll need to maintain detailed records of all the math so that tipped employees can reference how you arrived at the final figures.
Service Charges & Auto-gratuities
Technically, service charges and automatic gratuities (auto-grats), are not classified as gratuities by law. Since they are not an amount the customer spontaneously and voluntarily adds, they do not have the same legal restrictions as tips. Technically, service charges and auto-grats are the restaurant’s property, counted as revenue. And the restaurant can do whatever they want with them.
So, you can—as nearly all restaurants do—turn over auto-grats and service charges to the tip pool. Or you can give only a portion of these monies to the tip pool and give a portion of the service charge to the kitchen or catering salesperson who booked the large party. But in addition to the flexibility, service charges and auto-grats are seen as revenue by the Internal Revenue Service (IRS). So, if you put auto-grats in the tip pool, you’ll need to pay payroll taxes on those amounts in addition to the Social Security and Medicare taxes you pay on distributed tips.
POS Tip Management
If all this tip out and tip pooling sounds like way too much math on a daily basis, you should know that several modern restaurant POS systems can manage your tip outs or tip pools for you. Our favorite restaurant POS, Toast, for example, includes a Tip Manager that will automatically calculate simple and complex tip-sharing arrangements.
The Toast POS system includes detailed tip allocation settings so you can set your tip rules and let the software do the rest. (Source: Toast)
POS brands and app developers have been refining this software for awhile, and it has come a long way in recent years. So, if you looked at tip management software and disregarded it before 2020, it’s worth another look. You can read more about Toast’s specific workforce management tools in our full Toast review.
Or, you can get started with Toast for $0 per month and $0 upfront for hardware. Visit Toast for more information.
Tip Out Frequently Asked Questions (FAQs)
Can tip out include the kitchen staff?
Earlier versions of the FLSA prohibited distributing tips to staff members not directly “in the chain of service” tableside. However, a 2018 update to the FLSA permits some staff members who are not in the dining room to be included in tip pools.
To include kitchen staff in a tip pool, the employer must:
Pay all of their staff the full minimum wage.
Not claim a “tip credit” for any of their staff.
The FLSA update does not permit restaurants claiming a tip credit to distribute tips to staff that are not directly involved in the chain of service. And your state labor laws may prohibit it entirely. So, be sure to check your local labor laws before tipping out kitchen staff.
Can restaurant owners recoup credit card processing fees for credit card tips?
If an employer pays a processing fee to a merchant service to accept credit cards from customers (such as 3%), laws in some states permit them to retain the credit card processing fee from employees’ tips paid via credit card. In most cases, an employer would be required to notify the employee of the practice in writing before withholding these amounts.
In addition to notifying employees in writing, restaurant owners who transfer the costs of credit card transaction fees to their tipped staff must also:
Keep an accurate record of these charges.
Only charge the fee that they pay to their credit card processor.
Charge the fee to the correct employee.
Restaurants that claim a tip credit have an additional consideration. The FLSA does not permit recouping credit card fees if recouping those fees would place the employee’s total pay below federally mandated minimum wage.
How quickly must a restaurant owner distribute tips?
This varies from state to state, but credit card tips generally must be paid out by the next pay period. In some states cash tips can also be collected by the restaurant and distributed on the next paycheck. However, most restaurants permit service staff to retain, distribute, and report cash tips separately from credit card tips. Typically the service staff would distribute the cash among themselves at the end of the shift, and report those totals to the restaurant manager so they can be logged for tax withholding purposes.
Restaurants that treat cash tips separately from credit card tips should make IRS Form 4070-A available to their employees to ensure that cash tips are being recorded and reported for tax withholding purposes.
Can a server be fired for not tipping out?
In most states, yes, a server can be terminated for not complying with the restaurant’s posted tip sharing policy. Though, as an owner or manager, it is your obligation to ensure that your tip out policy adheres to all local labor laws. You should also provide your tip out policy in writing to all your tipped staff before their first day collecting or receiving tips. Some states require this, but it is a best practice even if your state does not require it.
Why do restaurants still allow tipping?
Tips act as a de facto commission on sales, which is a big concern since restaurants rely on their servers to sell their food and beverages before they spoil. Many restaurant workers also prefer receiving tips. So, in an industry in the midst of a record staffing shortage, tips can help restaurants attract and retain front-of-house workers. Including kitchen staff in tip outs can help encourage retention in the back of house, though this is still not a common practice throughout the industry.
Aren’t no-tipping restaurants more fair?
No-tipping restaurants have the potential to more equitably compensate their workers in the front and back of house. But it is important to point out that, currently, no laws compel them to do so. Labor law from the federal to state level protects tips and gratuities, drawing clear distinctions about who can be included in tip pooling arrangements and how and when tips must be paid out. This ensures that tipped workers’ interests are protected.
Given the way current labor laws are structured, restaurants that allow tipping and follow their local labor laws may actually pay their employees more equitably than restaurants that do not accept tips. Especially if those restaurants’ compensation structures are built through service charges. A restaurant can use the funds from a service charge for anything, from paying the rent to paying their staff. There is no guarantee that a service charge is being used to compensate the employees.
Do restaurant owners pay payroll taxes on tips?
If tipped employees earn more than $20 per month in tips, employers are obligated to withhold Social Security, Medicare, and income taxes from the reported tips, as well as paying the employer’s portion of Federal Unemployment Tax (FUTA) and Federal Insurance Contribution (FICA) on reported tips. It is a good idea to have all tipped employees track their tips on IRS form 4070-A to ensure that the appropriate taxes are being withheld.
Bottom Line
Tip outs—and tip pools—have been a part of the restaurant business model for generations. There may be no single solution that works for every restaurant. The best place to begin deciding which tip out model is right for your business is with the federal and local labor laws that govern tips and service charges in your area. Whichever model you choose, be sure that you are reporting all tips received by and distributed to your employees so that the appropriate taxes can be withheld.
