Credit card tips, often called charge tips, involve a complex flow of money and regulatory oversight compared to cash transactions. Credit card gratuities must pass through multiple financial systems and payroll processes before reaching the employee. This process introduces complications, including transaction fees, reporting requirements, and timing obligations that affect the final amount an employee receives. This article breaks down the journey of a credit card tip, from the customer’s card to the employee’s bank account, and the rules governing that transfer.
The Legal Status and Ownership of Tips
Under the Fair Labor Standards Act (FLSA), tips are the property of the employee, not the employer. This is true even if the employer takes a “tip credit” toward their minimum wage obligation. The money belongs to the employee from the moment the transaction is complete.
This legal ownership distinguishes tips from service charges, which are mandatory fees added to a customer’s bill. Since service charges are not voluntary payments, the employer legally owns them and determines distribution. If any portion of a service charge is distributed to employees, it must be included in the calculation of the employee’s regular rate of pay for overtime purposes.
Tracking the Credit Card Tip from Customer to Business
The delay in receiving a credit card tip results from the multi-step financial process required for settlement. When a customer completes a payment, the transaction moves from the Point-of-Sale (POS) system to the merchant processor, requesting authorization from the customer’s bank.
Once authorized, the transaction, including the tip, is batched for settlement, usually at the end of the business day. The funds travel through card networks, such as Visa or Mastercard, to the customer’s issuing bank and then to the business’s acquiring bank. This settlement process typically takes one to three business days before the funds are deposited into the employer’s account. The employer must receive the money before they can disburse the tip to the employee.
Employer Obligations Regarding Tip Reporting and Timing
Federal regulations require employers to pay out tips no later than the regular payday for the period in which the tips were earned. An employer cannot hold tips while waiting for the funds to clear the processing system; they are legally obligated to cover the amount first.
The employer also has mandatory reporting duties to the Internal Revenue Service (IRS). Employees must report tips to the employer, often monthly using Form 4070, if they receive $20 or more in tips during the month. The employer uses these reports to calculate and withhold appropriate income, Social Security, and Medicare taxes from the employee’s regular wages. Credit card tips are factored into the FLSA’s tip credit provision, which allows an employer to use a portion of the tips to meet the federal minimum wage requirement.
Understanding Deductions and Credit Card Processing Fees
Tips are considered taxable income, and employers must withhold mandatory taxes, including federal income tax, Social Security, and Medicare, from the total tip amount. These tax withholdings are legal deductions that reduce the final take-home amount. Employers must ensure the employee’s total wages, including any tip credit, do not fall below the applicable minimum wage after deductions.
Federal law permits an employer to deduct a proportional amount of the credit card processing fee from the employee’s tip. For instance, if the processing fee is 3%, the employer can reduce the tip payout by 3% of the tip amount to cover the transaction cost. The employer cannot deduct more than the actual cost of processing the tip, and this deduction is prohibited in some states that have stronger tip protection laws.
Common Methods for Tip Payout
Businesses use several methods to transfer collected tips to the employee.
Integration into Payroll
This is the most common practice, especially for large operations. The gross tip income is processed through payroll, taxes are withheld, and the net amount is added to the employee’s direct deposit.
Instant Digital Payment Systems
For faster disbursement, establishments may use instant digital systems. These include specialized tip cards, instant payout apps, or direct transfers to an employee’s debit card.
Daily Cash Payout
Less common is a daily or shift-end cash payout. The employer calculates the net credit card tips and pays the employee that amount in cash, often using the day’s cash sales.
Rules and Regulations for Tip Pooling and Sharing
Tip pooling is an arrangement where employees combine a portion or all of their tips for redistribution among a group of workers. The legal rules for tip pooling depend on whether the employer takes a tip credit against the minimum wage obligation.
If an employer takes a tip credit, they can only require tipped employees to share tips with other employees who customarily receive tips, such as bussers or bartenders. If the employer pays all employees the full federal minimum wage, they may implement a wider tip pool that includes non-tipped employees, such as cooks or dishwashers. Federal law prohibits managers, supervisors, and owners from receiving any portion of the tip pool. Managers may keep tips they receive directly from a customer for service they personally provide, but they cannot receive a distribution from the shared pool.