Wage and Hour Division Issues New Regulations Affecting Tip Credits

New regulations issued by the Wage and Hour Division of the Department of Labor (DOL) interpreting the Fair Labor Standards Act (FLSA) recently went into effect; but the National Restaurant Association (NRA) and other industry groups are challenging the regulations.

The new regulations, which became effective May 5, 2011, made significant changes to tip credit regulations.

The hospitality industry often relies on the tip credit to manage its labor costs while fairly compensating employees engaged in direct customer service. An employer may take a tip credit and pay a cash wage of at least $2.13, as long as the employee earns enough in tips to make up the difference to the minimum wage of $7.25. The DOL insists that its tip credit regulations be precisely followed, though:  “Where an employer does not strictly observe the provisions of [29 U.S.C. § 203(m)], no tip credit may be claimed and the employees are entitled to the full cash minimum wage.” See DOL Field Operations Handbook 30d01(b). As a result, it is critical that the tip credit be applied lawfully.

The tip credit can only be applied to those who qualify as tipped employees. A “tipped employee” is an employee engaged in an occupation in which the employee customarily and regularly receives more than $30 a month in tips. 29 U.S.C. § 203(t).

A tip is a sum presented by a customer as a gift or gratuity in recognition of some service performed for the customer. 29 C.F.R. § 531.52. It is to be distinguished from payment of a charge, if any, made for the service. Whether a tip is to be given, and its amount, are matters determined solely by the customer, and generally he or she has the right to determine who shall be the recipient of the gratuity. Tip pooling is permissible to permit service-oriented employees who may not receive direct tips (e.g., service bar tenders, bar backs, bussers) to accept tips from other tipped employees, and to take a tip credit against these employees’ minimum wage.

Litigation Filed by Industry Associations

On June 16, 2011, the NRA, Council of State Restaurant Associations and National Federation of Independent Business filed suit against the DOL over the amended regulations. The NRA has stated that the amended rule affects hundreds of thousands of businesses that employ tipped workers. The suit was filed seeking declaratory and injunctive relief because employers had no opportunity to comment on the new regulatory requirements and the DOL gave employers only 30 days to comply.

Change to Tip Credit Notice Provision

The regulations have long required employees to be notified if the employer will take the tip credit, but the amended regulations contain further, more detailed requirements. 29 C.F.R. §§ 531.54 and 531.59(b) require that employers inform tipped employees “in advance of the employer’s use of the tip credit of the provisions of [S]ection 3(m) of the Act.”  29 C.F.R. § 531.59(b). The regulations expand the notice requirement to include that the employer must inform employees of the following: (1) the amount of the cash wage that is to be paid to the tipped employee by the employer; (2) the additional amount by which the wages of the tipped employee are increased on account of the tip credit claimed by the employer, which amount may not exceed the value of the tips actually received by the employee; (3) that all tips received by the tipped employee must be retained by the employee except for a valid tip pooling arrangement limited to employees who customarily and regularly receive tips; and (4) that the tip credit shall not apply to any employee who has not been informed of these requirements in this section. Employers also must notify employees of any required tip pool contributions. 29 C.F.R. § 531.54. Although the regulations do not require that the employer provide the notice in writing, the DOL will make it difficult for the employer to meet its burden of demonstrating notice without written acknowledgments of the notification.

Employees Are Owners of Tips

Even though the FLSA only addresses “tips” in the context of the tip credit, the DOL’s new regulations now address ownership of tips even in cases where employers already pay at least the full minimum wage in cash. The amended regulations state that “[t]ips are the property of the employee whether or not the employer has taken a tip credit.” 29 C.F.R. § 531.52. Further, the employer “is prohibited from using an employee’s tips” regardless of whether or not the employee has taken a tip credit, except for a valid tip credit and tip pool. The regulations expressly reject the holding of the Ninth Circuit Court of Appeals in Cumbie v. Woody Woo, Inc., 596 F.3d 577 (9th Cir. 2010) that, when no tip credit is taken, tips are only the property of the employee when there is no agreement between the employer and employee stating otherwise. The conflict between the Ninth Circuit decision and the regulations leaves open the question of tip ownership in Ninth Circuit states and therefore may be the subject of continued litigation.

No Tip Pooling “Maximum Contributions”

The new regulations provide that “Section 3(m) does not impose a maximum contribution percentage on valid mandatory tip pools, which can only include those employees who customarily and regularly receive tips.” This replaces the DOL’s previous interpretation in its Field Operations Handbook stating that the net amount of tips contribution should not exceed 15 percent of the employees’ tips.