How Do I Calculate a Tip Credit?
When a customer leaves a few bucks on the table for their server, they are playing a major part in the restaurant economy. Waitstaff really do work for tips -- almost two-thirds of their income comes from gratuities left by customers.
Tips are good for staff and good for you, their employer. Not only do tips boost wages, they also encourage your customer-facing staff to do their best to wow every single diner that comes into your restaurant.
The only drawback is that it can sometimes be a headache to figure out how to calculate payroll for tipped employees. Here's what you need to know.
What Is a Tip Credit?
Tip credit is a way of including gratuities in calculations of minimum wage.
As an employer, you have to ensure that your staff's earnings are in line with minimum wage laws. For example, say you have a waiter who qualifies for the federal minimum wage of $7.25. That waiter works 40 hours over the course of a week, which means that they need to earn a minimum of $7.25 times 40, or $290.
But some of that $290 can come from tips. The value of tips counted towards minimum wage is the tip credit.
Who Qualifies for Tip Credit?
Tip credit only applies to tipped workers, who are any employees that regularly earn over $30 per month in gratuities. Tips can come directly from customers, or they can come from other employees if there is a tip-pooling arrangement.
Non-tipped workers don't qualify for tip credit, and you must pay them the full minimum wage as salary.
What Are the Federal Tip Credit Rules?
The Fair Labor Standards Act (FLSA) sets out the basic rules for how to calculate payroll for tipped employees. The legislation includes a few key figures that you need to know:
Minimum wage is $7.25.
Maximum tip credit is $5.12.
Overtime rates apply after 40 hours worked in one week.
Unless you're subject to other state or municipal laws regarding minimum wage, you have to stay within FLSA guidelines.
What Are the Local Tip Credit Rules?
In practice, there's a good chance that you do have some local rules that affect how you calculate payroll for tipped employees.
Some 29 states have their own minimum wage laws. These all set different minimum wage rates and different tip credit rates. There are also different rules about who qualifies as a tipped employee.
To make matters more complicated, you may also be subject to local and municipal laws that govern payroll for tipped employees. For example, here in Seattle, the minimum wage is $15 for small employers who don't contribute to employee health insurance. Seattle tip credit is $3, which means that the effective cash minimum wage rate is $12.
It's a complicated situation, and you would do well to speak to an expert who understands the restaurant industry when putting your payroll process in place. Remember -- you always have to go with whichever law provides for the highest minimum wage.
Do Service Charges Count as Tips?
The IRS makes a distinction between tips and service charges. The difference is pretty straightforward: tips are voluntary and service charges are not. If it's a fixed, non-negotiable amount that's added to the bill, it's a service charge.
Service charges are not tips. They are payments made to you, the restaurant owner, so you keep them, and you are liable for tax on them. If you pass some of the service charge onto your employees, that counts as a salary payment.
Tip Credit for Overtime Hours
If an employee works over 40 hours in a week, you need to pay one-and-a-half times their regular salary for the additional time worked.
That's one-and-a-half times their salary before tip credit. So, someone on $7.25 per hour gets an overtime rate of $10.88 per additional hour.
You can still apply the tip credit of $5.12 per hour to each overtime hour, but you have to make up the remaining $5.76 as a cash payment.
How to Calculate Payroll for Tipped Employees
So, now that you understand the rules regarding tip credit, how do you apply them to your restaurant payroll?
Make Sure Employees Are Reporting All Tips
Hopefully, your employees will report all tips voluntarily. If not, then remind them of why it's in their best interests to do so:
Tips are taxable, so failure to declare them is breaking the law.
Underreporting could impact their eligibility for things like Medicaid and Social Security.
Low figures on their wage slips could affect their ability to apply for credit.
It's unfair to keep tips if there is a staff tip-pooling scheme.
Calculate Average Hourly Tips
This is the total value of tips earned during the working period, divided by the hours worked. So, if someone brought in $400 in a 40-hour period, they made $10 per hour in tips.
Calculate Total Tip Credit for the Period Worked
The maximum hourly tip credit is $5.12 (or possibly lower, depending on local labor laws). In the example above where a worker earned $10 per hour in tips, you can only apply up to $5.12. If the employee made less than $5.12, then the tip credit is equal to whatever they earned.
Multiply the tip credit by the total number of hours worked in the pay period. For someone who worked 40 hours and earned over $5.12, that's a total tip credit of $204.80.
Consider Any Post-Tax Deductions
Sometimes you may need to make salary deductions -- for example, to cover the cost of an employee uniform. If a customer paid by card and added a tip, you're allowed to apply a reasonable deduction to cover card transaction fees.
However, you can't apply any deductions of this kind if they take the employee below minimum wage. Make a note of these deductions and see how they impact your payroll calculations.
Calculate Salary Based on Minimum Wage Requirements
Work out what the employee should be getting -- for an employee covered by FLSA rules working 40 hours, that's a total of $290.
Now subtract the tip credit from that amount. If the employee earned the full $5.12 per hour tip credit, that's $290 minus $204.80. You then need to pay the balance of $85.20 as salary.
Remember, you can't take deductions from that salary amount if it brings the worker below the minimum wage.
Apply Pre-Tax Deductions
You will now need to apply the usual payroll deductions, such as income tax and Social Security.
For tipped employees, this gets a little tricky. You have to calculate the applicable tax on all tips earned, not just the tip credit. You then need to withhold the correct amount and remit it to the tax authorities as you would for any other employee.
If the employee is making a lot of money through tips, this could mean that the taxable amount is more than their cash salary. If you get to the end of the tax year and the employee still owes some money, note the deficit on their W-2. Make sure the employee knows that they might have to pay some additional taxes.
Issue Paycheck and Wage Slips
Transparency is the key to keeping your employees happy. That, and paying them on time. Make sure that their wage slips include all details of your calculations and be ready to answer any queries they might have.
Get Payroll Right Every Time
Restaurant payroll is more complicated than people realize. It takes a lot of work to make sure that everyone gets paid fairly, that all taxes stay up to date, and that you remain on the right side of labor laws.
Talk to Honest Buck accounting to find out how we can help you. We specialize in accounting for restaurants and cafés, so we can do the paperwork and leave you free to focus on your customers.