What is a tip credit?
A tip credit is a legal provision that allows employers in specific industries, such as restaurants and hospitality, to count a portion of employees' tips toward meeting the federal or state minimum wage requirements. This means businesses can pay tipped employees a lower direct cash wage as long as their total earnings—including tips—meet or exceed the minimum wage.
For businesses using Homebase payroll, correctly applying tip credits ensures compliance with labor laws while helping manage payroll expenses efficiently.
How does a tip credit work?
Under the Fair Labor Standards Act (FLSA):
- Employers can pay tipped employees a direct wage of $2.13 per hour at the federal level.
- Employees’ total earnings, including wages and tips, must meet the federal minimum wage of $7.25 per hour.
- The maximum tip credit an employer can claim is $5.12 per hour.
Each state may have different tip credit rules; some prohibit tip credits entirely. Employers should check state and local wage laws to ensure compliance.
Which businesses can use a tip credit?
Employers can apply a tip credit if:
- The employee regularly earns more than $30 per month in tips.
- The combined wages and tips meet or exceed the required minimum wage.
- The employer notifies the employee in writing about the tip credit.
- Employees are allowed to keep all tips, except for legal tip pools.
Each state sets its own rules regarding tip credits, and some states prohibit tip credits entirely. Employers should check state and local wage laws to ensure compliance.
Calculating tip credit
To determine the correct tip credit amount:
- Identify the higher of the federal or state minimum wage.
- Subtract the direct wage paid to the employee.
- The difference is the tip credit, which tips must cover.
For example, if the minimum wage is $7.25 per hour and the employer pays a direct wage of $2.13 per hour, the maximum tip credit is $5.12 per hour. If an employee’s tips do not bring them up to the minimum wage, the employer must pay the difference.
What if an employee’s tips do not cover the tip credit?
If an employee’s total earnings (base wage + tips) do not meet the minimum wage, the employer must pay the difference to ensure compliance with wage laws. Failure to do so can result in:
- Wage and hour violations
- Legal penalties and back pay claims
- Fines from the Department of Labor
How to track and manage credits effectively
To ensure compliance, businesses should:
- Keep accurate payroll records showing wages and tip earnings.
- Use time-tracking and payroll software to automate wage calculations.
- Inform employees about tip credit policies in writing.
- Review state laws for any additional tip credit regulations.
Manually tracking tip credits can be time-consuming, but payroll software like Homebase can handle it automatically, helping you stay compliant without extra effort.
Homebase simplifies tip credit payroll
Handling tip credits and wage compliance can be overwhelming, but Homebase payroll streamlines the process by:
- Automatically calculating wages and tip credits based on labor laws
- Tracking employee tips and ensuring accurate wage payments
- Providing detailed payroll reports to maintain compliance
- Ensuring tax and labor law compliance at the federal, state, and local levels
If you're looking for an easier way to manage tip credits and payroll, Homebase can help. Learn more and get started today.