The American custom of tipping wait staff can lead to wage-hour compliance issues under California and federal law. Because of tips, wait staff may be among the highest compensated employees in a restaurant, sometimes earning more than their managers. Meanwhile, cooks who prepare the food typically earn only a fixed wage, and dishwashers may work for minimum wage. Yet, each of these employees contributes to the customer’s dining experience.

Some restaurants/bars attempt to address this potential inequity by requiring employees to “pool” their tips, which are then distributed in accordance with a formula. Formulas vary by restaurant. For example, the restaurant might require wait staff to pool all their tips. The pooled amount is then doled out based on predetermined percentages – for example wait staff might receive 40 percent of the pool, with lesser percentages being divided between other employees. The employees who benefit from the pool also vary, but might include hostesses and bussers, for example. Some pools include allocations to “back-of-the-house” employees (such as cooks and dishwashers), presumably in recognition of their contribution to the experience that, at least in part, prompted the tip.

A recent federal court decision interpreting the federal Fair Labor Standards Act limits who may lawfully participate in tip pools. The decision may affect California employers and employees in the hospitality industry who participate in tip pooling.

A Tip is a Gift

Both California and federal laws start with the proposition that a tip belongs to the employee and not the employer. That is because the employer does not pay the tip; it is a gift from a customer to service staff. Therefore, under federal and state laws, the restaurant owner may not keep any portion of the tip.

These laws do permit restaurants to control how tips are shared via tip pools. California and federal law differ significantly on two issues: whether the employer may take a “tip credit” towards the obligation to pay at least minimum wage, and the lawful recipients of tips from the pool.

Tip Credits

Under federal law, a restaurant may count tips towards the minimum wage obligation. The restaurant must pay just $2.13 of the $7.50 federal minimum wage, so long as the employee earns tips that equal or exceed the remaining $5.37. Such “tip credits” benefit the restaurant owner (by paying lower hourly wages) and disadvantage the wait staff (because the first $5.37 of tips each hour essentially is treated as part of the minimum wage).

California prohibits employers from relying on tip credits in the calculation of state minimum wages. California’s minimum wage – currently $10 an hour and set to increase to $15 over the next several years – is much higher than the federal minimum. California employers pay the full minimum wage. So, wait staff in California earn the full minimum wage, plus tips.

Tip Pools

Both California and federal law forbid owners and their agents (such as managers) from taking tips from service staff or participating in tip pools. Restaurant supervisors and managers cannot attempt to shift costs of running the business onto their wait staff by including in the tip pool such people as the restaurant’s bookkeepers and security staff.

However, California and the federal government differ on who else may be included in tip polls. The U.S. Department of Labor forbids “back-of-the-house” staff from being included in the tip pools. This regulation lessens the effect of the tip credit, by allowing service staff to keep more of their tips.

In California, the service staff receive tips over and above the hourly minimum wage. In exchange, California law allows owners to require that wait staff share those tips with their back-of-the-house co-workers if they are somehow responsible for the preparation and service of the meal.

The Effect of New Federal Regulations

In 2011, the federal Department of Labor issued a new regulation that eliminated the distinction between employers who paid the minimum wage and those who relied on tips to supplement it. These federal regulations deviated from California’s law by excluding back-of-the-house workers from tip pools. Earlier this year, a federal court upheld the regulations’ validity in Oregon Restaurant and Lodging Association LLC v. Perez.

Because federal law trumps California law when it is more generous to employees (here, wait staff), the federal interpretation of the permissible composition of a tip poll controls in California. The net effect is a big win for service staff employees in California, who are not subject to tip credits and need not share their tips with cooks and dishwashers. Employers on the other hand may not subsidize production employees’ wages (e.g., cooks) with tips, presumably resulting in higher payroll costs on top of the higher minimum wage.

Items for Employers to Consider

Employers using tip pools must ensure pools comply with both federal and state law. Some restaurant owners are considering alternatives to tip pools, including leaving the practice of sharing tips completely optional. Other restaurants are experimenting with eliminating tipping altogether, by increasing food and beverage prices to cover service costs or imposing mandatory service charges. Such service charges normally are not considered a gratuity given to the server and can be divided (or not divided) among staff members as the owner sees fit.