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Q & A: Tips

Q: I remember hearing about changes to the tip credit. What do I need to do to make sure I am in compliance?

A: New tip credit rules from the federal Department of Labor (DOL) went into effect in 2011 and address what information must be provided to the employee by the employer in order for the employer to take advantage of the tip credit.

What exactly is the tip credit?
The federal Fair Labor Standards Act (FLSA) allows an employer to pay a tipped employee an hourly wage less than the legal minimum wage under certain circumstances. In Wisconsin, the base/cash wage can begin at $2.33 an hour. The tipped employee’s tips and hourly wage when combined must equal at least the minimum wage (currently $7.25 an hour). The difference between minimum wage and the employee’s hourly wage is known as the tip credit. The amount of the tip credit can vary depending on the base/cash wages paid, but can’t exceed $4.92. If, over a pay period, an employee does not receive enough money in tips plus actual base/cash wages to bring him or her up to the full minimum wage, the employer must increase the base wage to make up the difference. If a restaurant takes the tip credit, their employees would need to be informed of that.

What’s New?
It was always recommended that employers inform employees that the tip credit was being utilized; the rules now require that employers must notify their employees. While this notification can be done verbally, it is strongly recommended that employers provide written notice, to make the evidence of their compliance indisputable.

This notice must include the following five points:

  • Amount of direct base/cash wage to be paid to the employee (in Wisconsin the minimum base/cash wage is $2.33 an hour)
  • Amount the employer claims as a tip credit (e.g. the difference between $2.33 and $7.25 an hour)
  • The tip credit can’t exceed actual tip earnings
  • Employers can’t claim the federal tip credit unless they inform employees of the federal law’s provisions on the tip credit
  • The law requires that employees retain all their tip earnings, with the exception of contributions to valid tip pools

What Constitutes a Valid Tip Pool?
The guidelines for what is considered a valid tip pool haven’t changed. To review, a tip pool can only include those employees who customarily and regularly receive tips. Employees who don’t typically receive tips like cooks and dishwashers (and other back-of-the-house staff) may not participate in the pool. However, the new rules don’t set a limit on how much of their tips employees may be required to put in the pool. The rules now state that the law “does not impose a maximum contribution percentage.” In the past, the NRA and WRA had advised employers that the DOL would consider tip pools with a maximum threshold of 15% to be valid. Now that percentage is up to the employer. You must notify your employees how much they will be required to contribute to the tip pool.

Does WRA Have a Form I Can Use?
We created a basic template that you can use. Keep in mind, however, that you are responsible for informing each employee of their specific base/cash wage and the amount of tip credit being taken. This information may vary from employee to employee within a business (unless all tipped employees are paid the same base/cash wage).

Download the Tip Credit Employee Notice template

WRA advises that you put employee tip credit notification in writing, so if there is ever an audit you will be able to prove that you properly notified employees. Remember, restaurants that don’t follow the new DOL requirements could lose their right to use the tip credit, forcing them to pay the full minimum wage to tipped employees!

Q: At my restaurant everyone on staff contributes to the dining experience that our customers have so I think we should include everyone in the tip pool. Can I do this?

A: This is what the U.S. Department of Labor states on their Fact Sheet #15 Tipped Employees under the Fair Labor Standards Act: “The requirement that an employee must retain all tips does not preclude a valid tip pooling or sharing arrangement among employees who customarily and regularly receive tips, such as waiters, waitresses, bellhops, counter personal (who serve customers), bussers and service bartenders. A valid tip pool may not include employees who do not customarily and regularly receive tips, such as dishwashers, cooks, chefs and janitors.”

So, even though you view the dining experience as a collaboration between all of your employees – front of the house, back of the house, customarily tipped or not, the DOL is pretty strict about who is allowed in that pool! Keep in mind that employees in a management role should also be excluded from tip pools. In fact, the National Restaurant Association reveals in their Legal Problem Solver that when an employer-established tip pool includes any ineligible employees, including supervisors, the employer must reimburse those who contributed to the pool in an amount equal to the tips turned over to the ineligible employees, and the employer may lose its eligibility to apply a tip credit against the wages paid to employees. And to add to the pain, the employer would not be able to seek reimbursement from ineligible employees.

You may be aware that rules impacting the tip credit changed in spring of 2011 and one of the changes involves tip pools. While the guidelines for what is considered a valid tip pool haven’t changed (as described above, a tip pool can only include those employees who customarily and regularly receive tips - employees who don’t typically receive tips may not participate in the pool). The new rules address how much of their tips employees may be required to put in the pool. The rules now state that the law “does not impose a maximum contribution percentage.” In the past, the NRA and WRA had advised employers that the DOL would consider tip pools with a maximum threshold of 15% of employees’ tips to be valid. Now that percentage is up to the employer -- although it is unclear how the DOL will enforce their definition of “customary and reasonable” standard as to required contributions. You must notify your employee how much they will be required to contribute to the tip pool.

Q: I know my servers aren’t properly reporting their tips. Can I alter what they have reported to me when I know it’s less than what they earned? Also, how do I convince them that they need to accurately report their tips?

A: In response to your first question, it’s an emphatic NO! You absolutely may not change what your employees are reporting, even if you suspect that it is not accurate. If you do so, you put your ability to take advantage of the tip credit at risk. That could be an expensive mistake for your business.

As for your second question, I know from talking to WRA members over the years that it can be a real struggle to get across the importance of proper tip reporting to your employees. While the following information may not hit home with all employees – it points out the very real consequences to under reporting tips.

  • If the IRS determines that an employee has under reported tips, the employee may be assessed back income and FICA taxes, interest and penalties up to 50 percent of the back taxes owed.
  • Unemployment compensation is determined by payroll records, if tips are under reported and the employee becomes unemployed, he will receive smaller UC payments than what he would have otherwise been entitled to receive.
  • If the employee has disability insurance and has an accident, the insurance company will compute the loss of income based on payroll records (under reported tips = lesser payments).
  • Social Security payments are based on tax contributions. If tips are under reported, the employee will receive less Social Security money when he retires.
  • Reporting 100% of tips gives the employee an accurate record of income. This is critical when the employee applies for a loan to purchase a car or home or tries to obtain a credit card (banks do call employers to check on this)!

Take the time to educate your staff about tip reporting responsibilities! Some employees might not know what is required of them, or may have gotten misinformation at previous jobs. You might want to consider having a staff meeting on the subject or using paycheck inserts as reminders. If you are interested in obtaining paycheck inserts or need talking points for a staff meeting, contact the Hotline Team at 800-589-3211 for help.

Q: Sometimes my tipped employees’ paychecks aren’t big enough for me to take out all of the taxes. What do I do about that?

A: When employers withhold taxes from tipped employees’ paychecks, they base the amount withheld on both the tip income and cash wages employees receive. Sometimes tipped employees’ paychecks may not be big enough for the employer to withhold all the required income and payroll taxes. In this “$0 paycheck” situation, here are a few tips from the National Restaurant Association for employers and employees:

Be sure you are withholding all taxes in the proper order. State and federal laws set a particular order for withholding taxes. The priority of withholding taxes is as follows:

  1. Employee’s share of social security on cash wages (exclusive of tips).
  2. Federal income tax on cash wages (exclusive of tips).
  3. State withholding on cash wages (exclusive of tips).
  4. Employee’s share of social security on tips.
  5. Federal income tax on tips.
  6. State income tax on tips.
  7. Balance due on taxes carried forward from previous paychecks.
  8. Other payroll deductions.

Let your employee know that you weren’t able to withhold all the required taxes. They may want to set aside some extra money, or give you extra funds to apply toward these taxes, so they don’t get hit at tax time with a bigger tax bill because not enough taxes were withheld throughout the year.

If you’re not able to withhold the full amount of federal FICA (Social Security and Medicare) taxes due on reported tips, you are required to note this as “uncollected Social Security taxes on tips” on the employee’s W-2 form.

If you’re receiving $0 paychecks, be aware that you may owe more in taxes than you expect when you file your tax return. Some tip earners save a few extra dollars over the year so they don’t get caught short at tax time. Better yet, many tipped employees give extra money to their employers to apply to their tax withholding. This helps avoid any estimated tax penalties.

Q: If all of my tipped employees report their tips at 8% we’ll stay out of trouble with the IRS, right?

A: This 8 percent myth has been circulating throughout the foodservice industry for years and is 100 percent incorrect! This notion of 8 percent as the magic number for tip reporting probably stuck in people’s minds because it is the number associated with IRS Form 8027 (Employers Annual Information Return on Tip Income and Allocated Tips). Some businesses are required to file this form listing the business’s annual gross sales and the total amount of tips reported by all tipped employees for the year. The total of reported tips on Form 8027 must be at least 8 percent of total reported sales, if this isn’t met the restaurant must allocate on to the individual tipped employee’s W-2 forms enough in unreported tips to bring the overall amount of tips up to 8 percent of sales. It isn’t an additional amount due to the employee, but is what the IRS assumes the employee should have reported and paid taxes on.

Your employees need to be reporting 100 percent of the tips, which granted can be a challenge. The IRS requires that tipped employees keep a daily tip diary (available from the WRA - $5 for a pad of 100). Remind your employees that if they don’t keep good records, the IRS can reconstruct tips when there are no records available. Warn employees that if tips look out of line, it raises a red flag for the IRS. If the IRS sees that on credit card charge slips an employee typically receives 15 percent tips, but reports cash tips of 5 percent, something is wrong.

Q: I’ve gotten complaints from some of my servers who feel they should get their entire tips (cash and credit card) immediately after their shift. Am I obligated to do that?

A: No, in fact the IRS recommends (but doesn’t require) that employers distribute tips received on credit cards through the regular payroll rather than as cash. If you do so, you must distribute them on the next regular payday – even if the payday arrives before you have collected the money from the credit card company. Make sure your employees are aware of this policy. You can post the following statement where servers can see it, or include it in your employee handbook: “Any tips you receive that are charged on credit cards will be paid to you on your next regular paycheck.”

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