Tip-Off on Tip Pooling: The Omnibus Spending Bill Amends the FLSA

President Trump signed a $1.3 trillion omnibus spending bill on March 23, 2018. Given limited coverage of specific provisions, restaurant owners may not realize that this legislation amended the Fair Labor Standards Act (FLSA) with respect to tips received by employees.
 
As amended, the FLSA prohibits employers from keeping tips received by its employees for any purpose, including   redistributing tips to managers and supervisors under tip pooling arrangements. This prohibition applies irrespective of whether the employer takes a tip credit toward its minimum wage obligation. Employers that violate these new rules face penalties that include reimbursement to tipped employees of the tips unlawfully kept by the employer and of tip credits taken. In addition, violators may face civil penalties of up to $1,100 per violation.
 
As a result of the FLSA amendment, tips can be shared with back-of-the-house employees such as cooks and dishwashers, but only if all employees are paid cash compensation that is at least equal to the full federal minimum wage. Employers that pay tipped employees—including the back-of-the-house employees that are intended to be included in a tip pool—less than full federal minimum wage in cash and use tip credits to bridge the gap, are not permitted to institute tip pools that include back-of-the-house employees.
 
To understand the significance of the provisions contained in the spending bill, it is helpful to understand the history.
 
1966: FLSA—The tip credit and tip pooling rules are established
The FLSA generally requires payment of at least the federal minimum wage (currently $7.25 per hour) to covered, nonexempt employees. An employer of tipped employees can satisfy this obligation by paying cash wages as low as $2.13 per hour and utilizing tips earned by employees to make up the difference between the lower cash wages paid and the cash wages required. If tips are not sufficient to make up the difference, the employer must pay the remainder in cash. This concept, known as taking a “tip credit,” was created by Congress in 1966 and was later amended in 1974. In order to take advantage of the FLSA’s tip credit provisions, all tips must be retained by the employee. 
 
The FLSA requirement that employees retain all tips when the tip credit is taken does not preclude valid tip pooling arrangements among employees that customarily and regularly receive tips, such as wait staff, bussers and bartenders. It has long been a permitted and widely used practice for employers that pay tipped employees cash wages below $7.25 per hour and rely on tip credits to satisfy minimum wage requirements to establish mandatory tip pools among front-of-the-house employees.
 
Nothing in the original text of the FLSA purports to restrict or police tip-pooling arrangements when employers pay full minimum wage to all employees without leveraging tip credits. In those circumstances, some employers established mandatory tip pools that included back-of-the-house employees. Other employers kept the tips for themselves or reinvested them in the business. Tipped front-of-the-house employees began to resort to litigation in order to prevent these employer actions. In some cases, courts ruled in favor of the restaurants’ tip sharing arrangements.   
 
2011: Department of Labor (DOL) issues controversial regulations
The DOL under the Obama administration issued regulations in 2011 in response to the litigation surrounding employer use of tips in instances where the employer paid wages at least equal to minimum wage (and, hence, did not take a tip credit). These regulations prohibit mandatory tip pooling with employees who do not customarily and regularly receive tips (i.e., back-of-the-house employees), even when the employer pays full federal minimum wage and does not use the tip credit. Voluntary tip sharing among front- and back-of-the-house employees continued to be permissible under the 2011 regulations, and front-of-the-house employees continued to be eligible for either mandatory or voluntary tip pools. 
 
Industry groups including the National Restaurant Association and state associations in Oregon, Washington and Alaska have long opposed the regulations as being overly restrictive, and petitioned the Supreme Court in 2017 to order the repeal of the regulations. Many opponents challenged the DOL’s application of the tip pool restrictions to employers who paid their employees full minimum wage, arguing that such restrictions should only apply (if at all) to employers who pay less than minimum wage and take advantage of the tip credit provisions.
 
In addition, because of state minimum wage increases over the years, the regulations produce particularly harsh results in states that require all employees to receive a high minimum wage. In those states, the inability to share tips among the front and back of the house produces a dramatic disparity between the total compensation (wages plus tips) earned by a server and the total compensation (wages without tips) earned by a cook, even though both of these employees enhance the customer experience.
 
Let’s look at an example:
Say a state requires all employees to be paid $10/hour, regardless of whether they receive tips. A server who works 40 hours/week and, on average, receives $20/hour in tips will have total compensation of $1,200. A cook working in the same restaurant who also works 40 hours/week will earn only $400 in compensation.
 
2017: Proposal to rescind the regulations
In late 2017, the DOL under the Trump administration published a notice that it intended to rescind the tip-pooling restriction contained in the 2011 regulations. According to the notice, employers that pay cash compensation to all of their employees equal to the full FLSA minimum wage would be considered the “owners” of all tips generated by their employees. As such, the employer could decide what to do with the tips, including who to share them with. This might include distributing them to non-tipped employees (including cooks, dishwashers, supervisors, and managers) or keeping the tips themselves. Owner justification for keeping employee tips is that they paid the tipped employees more cash compensation than they were required to under the FLSA.
 
Supporters of the 2017 rescission proposal said it would bridge the disparity between front- and back-of-the-house wages. Opponents of the proposal feared that it would lead to distrust among customers, who might ultimately tip less if they thought their tip would go to the restaurant itself rather than the individual staff member it was intended for. In extreme cases, opponents went on record to state that restaurants that retain tips were essentially stealing workers’ wages.
 
2018: Omnibus spending bill
The provision in this spending bill does two things: first, it curtails the 2017 proposal in that it expressly forbids employers from keeping tips under any circumstance. This is considered a victory for restaurant workers. Second, it codifies the 2017 proposal to allow mandatory tip sharing among the front and back of the house (so long as the employer pays cash compensation equal to the full FLSA minimum wage). This is in direct contradiction to the 2011 regulations, which limited mandatory tip pooling arrangement to employees who customarily and regularly receive tips (i.e., front-of-the-house employees). This is considered to be a victory for both workers and restaurants.   
 
BDO’s Take on the FLSA Amendments
The 2018 FLSA amendments provide a happy compromise for restaurants and employees, and industry groups representing both workers and restaurants claim victories as a result of the recent amendments. The 2011 regulations were considered by many to be overly restrictive, and the 2017 proposal to rescind these regulations was considered by many to have swung too far in the other direction.
 
At first glance, mandatory tip pools that include back-of-the-house employees may appear to provide greater benefits to those employees at the expense of front-of-the-house employees. However, the fact that tipped employees will end up with less tips may be mitigated by the required full federal minimum wage that they must receive as cash compensation from employers who want to utilize tip pools that include back-of-the-house employees. It is anticipated that tipped employees will not have to give up more in shared tips than they gain through increased minimum wage, and it is possible that tipped employees that receive a higher minimum wage will end up even better after tip pooling than their counterparts at non-tip pooling restaurants who receive lower minimum wage but can retain all of their tips.
 
Customers tip on good service and good food. Enabling tips to be shared with back-of-the-house employees will allow these employees to be recognized for their contributions to the overall customer experience, while still providing owners with flexibility. Restaurateurs should assess their customer experience, minimum wage laws, and service values when deciding the right tipping strategy for them.
 
Please note: Tip pooling policies should be carefully reviewed with counsel before implementation to ensure compliance with all applicable federal and state requirements.
 
For questions on your tip policy, contact Lisa Haffer, CPA, JD, at lhaffer@bdo.com.
 
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