Thanks for the Tip: U.S. DOL’s Proposed Rule and Potential Enhanced Availability of “Tip Pools”

By Xavier D. Lightfoot and Grant B. Osborne

The Fair Labor Standards Act of 1938 (“FLSA”), for decades, has permitted employers to pay some workers a lower minimum hourly wage than would otherwise be due if the workers receive at least a minimum amount per month in the form of customers’ tips.  The law regarding this established and well known tradition of many employees’ reliance on gratuities continues to evolve.    

The United States Department of Labor (“DOL”), on December 9, 2019, closed its extended comment period that allowed the public to weigh in on the DOL’s recent Notice of Proposed Rulemaking (“NPRM”) regarding the DOL’s regulation of employers’ use of customers’ tips.  Notably, the NPRM would do away with federal regulations that prevent certain employers from implementing mandatory “tip pools” requiring the participation of both tipped and non-tipped employees.  The proposed change is certainly a win for employers in the hospitality industry, but there are still challenges that employers must bear in mind. 

Background and Shift in 2011

The NPRM was issued in response to the Consolidated Appropriations Act of 2018 (“CAA”) that amended Section 3(m) of the FLSA.  Section 3(m), known as the “tip credit” provision, allows an employer to take a “tip credit” toward its minimum wage and premium overtime pay obligations to non-exempt tipped employees.  An employer’s tip credit may not exceed $5.12 per hour.  That is the difference between (a) the minimum required hourly cash wage that employers who are covered by the FLSA must pay in “direct wages” to non-exempt “tipped” employees (of $2.13) and (b) the minimum hourly wage (currently $7.25) that employers must otherwise pay to employees in accordance with the FLSA.  To take the tip credit, an employer must satisfy certain FLSA-requirements, such as a provision of notice to its employees providing: (1) the amount of direct wages that the employer is paying its tipped employees; (2) the amount claimed by the employer as a tip credit; (3) that the employer’s tip credit cannot exceed the amount of tips actually received by the tipped employee; (4) that tipped employees may retain all of their tips, with the exception of a valid tip pool; and (5) that the employer cannot take the tip credit unless the tipped employee has been informed of such tip credit provisions.  The FLSA permits employers to implement tip-pooling arrangements that require the sharing of tips among employees who “customarily and regularly” receive tips. 

In an attempt to attract and retain valued employees who are not customarily or regularly tipped by customers, such as “kitchen staff,” some restaurants have begun to implement mandatory tip pools involving both “front” and “back of the house employees.”  Such arrangements mean that servers are required to contribute their tips to a pool that is shared with non-tipped workers, e.g., cooks and dishwashers.  The use of such arrangements has been litigated and is now approved with the passage of the CAA.  For example, the United States Court of Appeals for the Ninth Circuit, in Cumbie v. Woody Woo, Inc.,  ruled in 2010 that the FLSA does not prevent this kind of tip-pooling arrangement by employers who do not take a tip credit (i.e., who pay non-overtime hourly wages of at least $7.25).

But such judicial pronouncements are not the last word.  In 2011, the DOL revised its regulations to provide that “tips are the property of the employee whether or not the employer has taken a tip credit.”  This regulation sought to end tip-pooling arrangements that involved tipped and non-tipped workers.  But it has not done so and has been the subject of much litigation throughout the country that has resulted in conflicting decisions. 

CAA and DOL Enforcement

As discussed, the CAA amended Section 3(m) of the FLSA, and the resulting amendments have had various effects.  First, the CAA made clear that the FLSA prohibits employers from keeping employees’ tips, regardless of whether the employer takes a tip credit.  Employers, as a result, may not lawfully include managers and supervisors in their tip pools (as explained below).  Second, the CAA suspended federal regulations that were designed to prevent employers who did not take a tip credit from creating mandatory tip pools that include both tipped and non-tipped employees.  (Such employers, as a result, may now lawfully implement such tip pools.)  Third and finally, the CAA provides the DOL with authority to impose civil monetary penalties of as much as $1,100 per violation on employers who unlawfully keep their employees’ tips.

The CAA, as one can see, has dramatically changed the law.  The NPRM, if adopted, would change the law too, by: (1) requiring use of the DOL’s  “duties” test for executive employees in determining whether an employee is a “manager” or “supervisor” under the FLSA; (2) eliminating the so-called “80/20 rule” that determines when an employer may use an employee’s tips as part of his or her wages for work that involves performance of both tipped and non-tipped duties; and (3) imposing a recordkeeping requirement that would require employers who do not take a tip credit and employ mandatory tip pools to (i) identify in payroll records every employee who receives tips and (ii) maintain records of the weekly or monthly amount of tips received as reported by each employee.

Under current rules, a non-exempt tipped employee is entitled to a direct wage equal to the federal minimum wage when more than 20% of his or her work during a shift consists of non-tipped-related work.  Administrative and practical difficulties have arisen from this rule, and the DOL has admitted that it has confused employers.  The newly proposed rule would permit employers to take a tip credit toward wages due for any amount of time that a tipped employee performs tipped and non-tipped duties, so long as the employee performs the non-tipped duties contemporaneously with the tipped duties, or within a reasonable time immediately before or after performing the tipped duties.  Such evaluations, as one can readily see, may be fertile territory for debate and, possibly, more than occasional litigation.

The proposed rule does not change the settled doctrine that employers who take a tip credit based on the pooling of its employees’ tips and payment of such tips out of the resulting pool may do so only by maintaining tip pools that involve only traditionally tipped employees. 

Potential Challenges

As discussed above, under the proposed rule, the DOL will apply its established  “duties” test, as an enforcement policy, to determine whether an employee is a “manager” or “supervisor” whose participation in a tip pool would prohibit retention of employees’ tips.  This would mean, essentially, that the DOL could not find an employee to be a manager or supervisor unless all three of the following factors are satisfied: (1) the employee’s primary duty is management; (2) the employee customarily and regularly directs the work of two or more employees; and (3) the employee has the ability to hire or terminate other employees. Because of the DOL’s expected enforcement policy, employers, if the proposed rule is adopted, will be able to exclude one or more of the foregoing duties from certain lower-level managers and include them in a tip pool (and base “tip credits” toward wages due on payment of wages out of the pooled tips), without violating the FLSA.

Assuming that the DOL’s proposed rule is adopted as provided in the NPRM, it will probably be tested in the courts, as neither the FLSA nor the CAA defines “managers” and “supervisors,” and employers will seek ways to define those terms as narrowly as possible so that they may provide as many employees as possible with the opportunity to participate in tip pools and earn tips.

Key Takeaways and Tips

Employers who pay at least the full minimum wage to non-exempt and non-tipped employees will be able, if and when the proposed rules have been adopted, to include them in tip pools, so long as they are not “managers” or “supervisors,” and be freed of the obligation to track the times in which they perform tipped versus non-tipped work.  The CAA and proposed rule make it quite clear that an employer cannot lawfully retain an employee’s tips, but the determination as to who is, in fact, a “manager” or “supervisor” will remain up for debate.  The most conservative approach will militate in favor of barring all employees who perform any managerial function from collecting tips, whether individually or by participation in a tip pool. 

Employers must also keep in mind state-specific wage and hour laws regarding tipped employees.  Some states have stricter requirements providing employees with greater protections than the FLSA, and an employer’s tip policies must typically comply with both federal and state laws (although there are exceptions).  The law in this confusing area remains in flux.  Employers who wish to avoid running afoul of it and thus exposing themselves to troublesome governmental investigation(s) and/or potentially expensive litigation should consult experienced legal counsel for practical advice, as violation of the requirements, whether intentional or not, do not, unlike fine wine, improve with age.