What Is Tip Credit on My Paycheck?

When you receive a paycheck, it represents the compensation for your work, detailing your gross earnings, deductions, and net pay. For many individuals working in service industries, particularly those who regularly receive gratuities, understanding how tips impact their wages is important. One specific concept that influences the paychecks of these employees is the “tip credit,” a provision that can affect how their employer calculates their hourly wage.

What is Tip Credit?

Tip credit refers to a provision under the federal Fair Labor Standards Act (FLSA) that allows employers to pay certain employees less than the full federal minimum wage. This applies specifically to “tipped employees,” defined as those who customarily and regularly receive more than $30 per month in tips. Employers can take a credit for a portion of the employee’s tips against their minimum wage obligation.

The federal minimum wage is currently $7.25 per hour. Under the FLSA, an employer can pay a tipped employee a direct cash wage as low as $2.13 per hour. The difference between the direct cash wage and the full federal minimum wage, which is $5.12 per hour, is the maximum tip credit an employer can claim. This means the employer relies on tips to meet the federal minimum wage.

The combined amount of the employee’s direct cash wage and the tips they earn must at least equal the full federal minimum wage of $7.25 per hour for all hours worked. If an employee earns more than $5.12 per hour in tips, the employer can still only take a maximum tip credit of $5.12. The “credit” is not an amount paid to the employee but rather a reduction in the employer’s direct wage obligation.

Employer Requirements and Employee Protections

Employers who choose to take a tip credit must meet specific requirements. They must inform their employees in advance of their intent to pay a lower direct wage and claim a tip credit. This notification must clearly explain the direct wage, the tip credit amount, and that the combination of wages and tips will meet the federal minimum wage.

A significant protection for employees is the rule that they must retain all of their tips. An exception exists for valid tip pooling arrangements, where tips are shared among employees who customarily and regularly receive tips, such as servers, bussers, and bartenders. However, managers, supervisors, or owners are not permitted to participate in these tip pools.

Another important protection is the “80/20 Rule,” which applies when a tipped employee performs both tipped and non-tipped duties. If an employee spends more than 20% of their workweek performing duties that do not directly generate tips, such as cleaning or preparing for service, the employer cannot take a tip credit for that non-tipped time. For those hours, the employer must pay the full federal minimum wage of $7.25 per hour.

If an employee’s direct cash wage of $2.13 per hour, combined with their earned tips, does not reach the full federal minimum wage of $7.25 per hour for all hours worked in a pay period, the employer is legally obligated to make up the shortfall.

Understanding Your Paycheck and Rights

To understand how tip credit impacts your earnings, review your pay stub. Your direct hourly wage, potentially $2.13 per hour, indicates its application, even if tip credit isn’t a separate line item. Your gross earnings will reflect this direct wage, with tips accounted for to ensure minimum wage compliance.

It is advisable to keep your own detailed records of the tips you earn each day or shift. This personal log allows you to compare your actual tips against the amounts reported by your employer and ensures accuracy in your pay and tax reporting. Maintaining these records can also be helpful if any discrepancies arise regarding your wages.

Employees are responsible for reporting all cash and non-cash tips received to their employer for tax purposes, typically by the tenth of the month following the month the tips were received, using IRS Form 4070, Employee’s Report of Tips to Employer.

If you suspect your employer is not complying with tip credit laws, several steps can be taken. Initially, you might consider discussing your concerns directly with your employer or their human resources department, as misunderstandings can sometimes be resolved internally. If this does not resolve the issue, you can contact the U.S. Department of Labor’s Wage and Hour Division (WHD), which enforces federal labor laws like the FLSA. They can investigate complaints and help recover unpaid wages.