Question: How is overtime computed when the employer uses the tip credit to meet minimum wage requirements?
Answer: The tip credit allows an employer to pay a tipped employee at a rate less than the applicable minimum wage and apply employee tips to make up the difference. The Fair Labor Standards Act defines tipped employees as those engaged in an occupation in which they regularly and customarily receive more than $30 a month in tips.
Compensation for overtime must be paid at 1.5 times the employee’s regular hourly rate of pay. For tipped employees, the regular hourly rate of pay is either the highest applicable minimum wage or the amount of direct cash hourly wage paid by the employer, exclusive of tips, whichever is greater.
If the employee also provides services to the employer that do not constitute tipped employment, the regular hourly rate of pay changes. The employee’s regular hourly rate of pay would be the sum of all direct cash wages paid to the employee during the workweek, with any tip credits allowed to the employer during the workweek, and dividing that amount by the number of hours the employee worked during the workweek.
Under the FLSA, employers must pay cash or direct wages of at least $2.13 an hour to tipped employees and may apply up to $5.12 an hour of an employee’s tips to meet the current federal minimum wage of $7.25 an hour. The $5.12 per hour is the employer’s maximum allowable federal tip credit. If the employee’s tips are not sufficient to make up the difference between the minimum wage and the wage paid by the employer, the employer is required to make up the difference.
For example, if an employer pays wages of $3 an hour, the employer is allowed a tip credit of $4.25 an hour. If an employee received an average of $3.25 an hour in tips, the employer must pay an additional $1 for each hour worked to bring the employee’s hourly rate of pay for the workweek up to the $7.25 per hour minimum wage.
Alternatively, if the employee receives an average of $6 per hour in tips, the employer may only use $4.25 of the tips for the tip credit. The regular rate of pay for the employee for overtime computation purposes is $7.25 an hour, because tips exceeding the amount needed to attain minimum wage are not included in the regular hourly rate of pay.
To determine the employee’s overtime pay, assume the employer pays a cash wage of $3 an hour and claims a tip credit of $4.25 an hour. The employee receives $6 an hour in tips during a 45-hour workweek. The employee’s regular rate of pay is $7.25 an hour.
The employee is owed straight-time wages of $326.25 (45 hours x $7.25 an hour) plus an overtime premium of $18.13 (5 hours x 0.5 x $7.25 an hour) for total wages of $344.38.
The total tip credit for the workweek is $191.25 (45 hours x $4.25 an hour) and the direct or cash wage to come from the employer is $153.13 ($344.38 total wages - $191.25 tip credit).
During overtime weeks, the employer might be able to claim an additional state tip credit if the state minimum wage and allowable tip credit are greater than the federal amounts. This applies toward satisfying the employer’s required overtime compensation. The combined FLSA and additional state tip credit cannot exceed the employee’s actual tips.
For example, in a state where the state minimum wage is $10 an hour, the employer pays a cash wage of $3.35 an hour as required by state law and claims the maximum state tip credit of $6.65 an hour. The employee’s regular rate of pay is $10 an hour.
The employer may claim an FLSA tip credit of $3.90 an hour ($7.25 an hour - $3.35 cash wage an hour) for all hours worked during the workweek. If the employee works overtime during the workweek, the employer may claim an additional tip credit of $2.75 an hour. This is the difference between the state tip credit of $6.65 and the FLSA tip credit of $3.90.
Assuming the employee works 45 hours during the workweek, the employee is owed straight time wages of $450 (45 hours x $10 an hour) plus overtime premium of $25 (5 hours x 0.5 x $10 an hour) for total of $475.
The employer is entitled to a total FLSA tip credit of $175.50 (45 hours x $3.90 an hour) and a total additional tip credit of $123.75 (45 hours x $2.75 an hour).
The employer pays $175.75 in cash or direct wages. This is the $475 total wages owed minus the $175.50 FLSA tip credit and the $123.75 additional tip credit.
If the cash wage paid to the employee is greater than the federal minimum wage, no FLSA tip credit is allowed. However, an additional state tip credit may be taken if the state allows a tip credit. For example, if the state minimum wage is $8.50 and the employee is paid a cash wage of $7.75, the employer would not be allowed to claim a tip credit under the FLSA, but during an overtime week, the employer would be able to claim a state tip credit of $0.75 per hour worked during the workweek.
If the state does not allow a tip credit and the state minimum wage is equal to or greater than the federal minimum wage, the employer may not claim either the FLSA tip credit or an additional state tip credit.
This column does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Patrick Haggerty is the owner of a tax practice in Chapel Hill, North Carolina, and an enrolled agent licensed to practice before the Internal Revenue Service. The author may be contacted at phaggerty@prodigy.net.
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