Tip Pooling – Are the Rules Changing?

Paul Klockenbrink contributes to the “Virginia Hospitality Law Blog” and is a frequent lecturer on employment law issues.

A recent decision by a federal appeals court has sent minor, if not significant, shockwaves into the restaurant and hospitality industries that use tip pooling as part of their employees’ income.

Under Section 203(m) of the Fair Labor Standards Act (“FLSA”), restaurants and other hospitality industry employers are permitted to utilize a limited amount of employees’ tips as a credit against their minimum wage obligations by using tips as “wages.” This practice is known as taking a “tip credit.” An employer can pay tipped employees (1) a cash wage of $2.13, plus (2) an additional amount in tips that brings the total wage to the federal minimum wage. If the employer uses tips to help meet the minimum wage requirement for its employees, the employee must be informed of this fact and the employee must also be permitted to keep the tips, unless the employee is part of a tip pool with other employees who regularly receive tips. Therefore, if an employee earns $5.12 an hour in tips, it is permissible for a restaurant/hotel to only pay the employee $2.13 an hour in cash wages in order to meet the $7.25 federal minimum wage. In some states (not Virginia), employers are not permitted to take a tip credit because the particular state law requires them to pay employees the state or federal minimum wage regardless of the tips the employees receive.

Many employers have instituted tip pooling programs. Under these programs, employers sometimes require employees to share the tips they receive with workers in customarily non-tipped positions (such as back of the house staff, cooks, dishwashers, hostesses, etc.). Many courts have held that the FLSA permits these types of tip pooling arrangements so long as the employer does not take tip credits against the employee’s wages.

An ongoing hot issue in tip pooling arises when the employer decides (or is legally required) to pay the employees the federal or state required minimum wage and does not seek a tip credit. If the employer does not seek a tip credit, can the employer require its employees to contribute their tips to a tip pool that includes employees who are not regularly or customarily tipped? The Department of Labor says no. In 2011, the DOL issued a formal rule interpreting Section 203(m) that extended the tip pool restrictions of Section 203(m) to all employers, not just the ones who take a tip credit. Stated differently, the DOL says it can also regulate tip pooling arrangements of employers that do not take a tip credit because tips are the property of the employee. The DOL’s logic being that if an employer could require its employees to contribute their tips to a tip pool that included employees who were not regularly tipped, the employer would have no reason to ever elect the tip credit because instead of using only a portion of the employees’ tips to fulfill its minimum wage obligations, it could use all of its employees’ tips to fulfill its entire minimum wage obligations to the tipped employees, as well as the non-tipped employees.

The meaning of Section 203(m) of the FLSA and the validity of the DOL’s 2011 interpretation are currently the subject of lively debate in the federal courts. Most recently, the Ninth Circuit Court of Appeals (which includes several states in the West) in Oregon Rest. & Lodging Association v. Perez ruled in favor of the DOL’s 2011 interpretation of Section 203(m). The 2-1 decision, however, had a vigorous dissent and an en banc appeal to the full Ninth Circuit is expected.

Closer to home, restaurant and hospitality employers in Virginia can take some minimal comfort in a July 2015 decision from the Fourth Circuit Court of Appeals in Trejo v. Ryeman Hospitality Properties, Inc. In the Trejo case, the Fourth Circuit upheld the lower court’s dismissal of an employee’s challenge to a tip pooling arrangement. The Court did not, however, address the DOL’s 2011 regulation. Therefore, employers using tip pools in Virginia are left with uncertainty. Arguably, there remains the option of foregoing the federal tip credit and paying full minimum wage, thereby allowing broader tip pooling including – non-tipped employees. But, caution is recommended because the DOL says no and the judicial final chapter in this story has yet to be written.