Credit card tips have become the standard form of gratuity in the service industry, representing a substantial portion of an employee’s income. Since the vast majority of tips are processed electronically, the employer acts as an intermediary in the flow of money. The money paid by the customer is initially received by the business, which holds it in trust for the employee. This system involves legal compliance, transaction fees, and various disbursement methods that determine when and how a server ultimately receives their earnings.
The Credit Card Tip Flow
The process begins when a customer completes their transaction, writing the tip amount on the signed credit card receipt. This tip, alongside the cost of the meal, is instantly authorized on the customer’s card, but the money is not yet in the restaurant’s account. The transaction remains an open authorization until the server or manager enters the final total, including the tip, into the Point-of-Sale (POS) system.
At the end of the business day, the restaurant transmits a batch of all finalized credit card transactions to the payment processor for settlement. The funds, which include the total tip amount, are then transferred to the restaurant’s bank account, typically arriving within one to two business days. This means the employer is temporarily holding the employee’s tip money, requiring established procedures for accurate distribution.
Deducting Processing Fees
When a customer tips using a credit card, the employer incurs a merchant processing fee on the entire transaction, which includes the tip amount. The Fair Labor Standards Act (FLSA) permits employers to deduct the proportionate cost of this fee from the employee’s credit card tips before payment.
This deduction is lawful only if it represents the actual cost of processing the tip portion, not the entire sale. Furthermore, the deduction cannot reduce the employee’s total wages below the federal or applicable state minimum wage. Several states, including California and Massachusetts, prohibit employers from deducting these processing fees, requiring the business to absorb the expense. The right to offset these fees is limited strictly to the cost of collection.
Methods for Tip Disbursement
Employers have adopted several methods for distributing credit card tips, with the choice affecting the server’s immediate access to their earnings.
Paycheck Inclusion
The most common method involves including the credit card tips, net of any lawful deductions, in the server’s regular paycheck. This approach simplifies tax withholding and payroll processing, providing the employee with clear documentation of their income. However, it delays access to the funds until the next scheduled payday.
Daily Cash Payout
A second method is the daily cash payout, where the employer uses cash on hand to reimburse the server for their credit card tips at the end of the shift. The POS system tracks the server’s credit card tips, and the difference is paid out in cash from the register. This method provides immediate liquidity to the employee but requires the business to manage significant cash flow and daily reconciliation.
Digital Transfers
A third, increasingly common approach involves digital payment methods, such as tip cards or direct transfers to an employee’s personal bank account outside of the regular payroll cycle. These methods can offer a compromise between immediate access and accurate tracking. Federal regulations require that the full amount of the tip, minus any permissible deductions, must be paid to the employee no later than the regular payday.
Legal Requirements for Tip Pooling
Many service establishments implement tip pooling, which is a mandatory arrangement where all employees receiving tips contribute a portion of their gratuities into a collective pool for redistribution. Federal law dictates specific requirements for mandatory tip pools based on the employer’s wage practices.
Inclusion Based on Wages
If an employer claims the FLSA tip credit (paying a direct cash wage lower than the federal minimum wage), the mandatory tip pool can only include employees who customarily and regularly receive tips, such as servers, bartenders, and bussers. If the employer pays all employees the full federal minimum wage or higher, they are permitted to include traditionally non-tipped personnel, such as back-of-house staff like cooks and dishwashers, in the pool.
Exclusion of Management
Managers, supervisors, and owners are not permitted to keep any portion of an employee’s tips, whether directly or through a tip pool. A manager or supervisor may only keep a tip if they received it directly from a customer for service they provided solely and individually. This rule applies even if the manager performs non-supervisory work, clarifying that they may not receive distributions from the collective pool.
Tax and Reporting Obligations
Credit card tips are considered taxable income and must be reported to the Internal Revenue Service (IRS) by both the employee and the employer. Employees must report all tips, including cash and charged tips, to their employer if the total amount exceeds twenty dollars per month. The employer is responsible for withholding income tax and FICA (Social Security and Medicare) taxes from the tips and wages paid.
For large food and beverage establishments, the IRS enforces the 8% rule to address potential underreporting of tips. If total tips reported by all employees are less than 8% of the establishment’s gross receipts, the employer must allocate the difference among tipped employees to meet this threshold. The employee is responsible for reporting any allocated tips on their personal tax return, which requires filing Form 4137.
Employee Protections for Tipped Wages
The Fair Labor Standards Act (FLSA) provides specific protections to ensure tipped employees receive the wages they are owed. A common practice is the use of the tip credit, which allows an employer to satisfy a portion of their minimum wage obligation by combining a lower direct cash wage with the employee’s tips. The total of the direct wage and the tips must equal or exceed the federal minimum wage, or the higher state or local minimum wage if applicable.
Employers must pay all tips promptly, with distribution mandated no later than the regular payday for the workweek in which the tips were collected. The law strictly prohibits an employer from retaining any portion of a tip, except for the legitimate deduction of credit card processing fees. Employers are also forbidden from requiring employees to use tips to cover business costs, such as customer walk-outs or register shortages.