Will Your Tipping Policy Land You in Court?

Mar 03, 2016

By Aviva Kamm and Krista L. Nelson | Related Practices: Business and Employment

On February 23, 2016, a three-judge panel of the Ninth Circuit ruled in a long-awaited decision that the Department of Labor can regulate the tip-pooling policies of employers around the country, even if the employer is not using a “tip credit” to help it pay the employees’ minimum wage. This ruling reverses the rulings from the two federal trial courts which considered the issue before it was presented to the Ninth Circuit. Any employer with employees who receive tips from customers — whether the tips are paid by cash or credit and whether the tips are part of the employees’ base wage or extra income — should keep reading and consider whether your tipping policies and practices will meet the regulatory test.

Background

We all know the basics, right? Employees must be paid no less than the minimum wage, which in Washington in 2016 is $9.47 per hour.* The Fair Labor Standards Act (FLSA) allows employers to take a “tip credit” against their minimum wage obligation to tipped employees.  29 U.S.C. § 203(m).  The statute requires that tipped employees be notified of the tip credit before it is applied and that they retain all tips received, “except that this subsection shall not be construed to prohibit the pooling of tips among employees who customarily and regularly receive tips.” Even though federal law permits tip credits, employers in Washington are not allowed to use tips as a credit toward meeting minimum wage obligations.  WAC 296-126-022.

In 2010, a waitress in Portland, Oregon filed a class action lawsuit that challenged her employer’s tip-pooling practice. Cumbie v. Woody Woo, 596 F.3d 577, 583 (9th Cir. 2010). In Woody Woo, the plaintiff alleged that by requiring servers to pool their tips and then redistributing those tips among all employees — most of whom were kitchen staff — the employer violated the FLSA. The Ninth Circuit ruled that the FLSA does not restrict tip-pooling practices of employers who do not take tip credits. In other words, if an employer does not take the tip credit — as is true for all Washington employers — the employer is free to implement any tip-pooling policy it chooses — even one that requires pooling and sharing tips with “back-of-house” staff.

The Department of Labor (DOL) did not like the Ninth Circuit Woody Woo ruling and in 2011 revised the regulation to require that even employers who do not take a tip credit could only pool tips among customarily tipped employees, i.e. no pooling with “back-of-house” employees such as dishwashers. 29 C.F.R. §  531.52

The issue before the Ninth Circuit in last week’s case was whether the DOL had overreached its authority by extending the regulation to employers who do not take tip credits. In 2013, a group of restaurant and trade associations, which used tip pools, challenged the DOL’s rule. The employers’ tip pools required customarily tipped employees (front-of-house staff) to share tips with non-customarily tipped employees (kitchen and other back-of-house staff), but the employers did not take a tip credit. The Oregon trial court agreed that the 2011 regulations were invalid because the intent of the relevant section of the FLSA was only to limit the use of tips by employers when a tip credit is taken, and the FLSA did not expressly prohibit the restaurants’ practices. Last week’s ruling concluded that the DOL’s regulation is justified and enforceable. Oregon Restaurant & Lodging Ass’n v. Perez, 2016 WL 706678 (9th Cir. Feb. 23, 2016). Two of the judges found the statute and Woody Woo “left room” for agency discretion where the statute was “silent” with respect to employers who do not take a tip credit. The judges then reviewed the statute’s legislative history and found DOL’s interpretation of the statute more closely aligned with congressional intent and, at the very least, reasonable. The panel decided that the courts should thus defer to the DOL’s judgment as expressed in its regulation.

A third Ninth Circuit judge — one of the three who decided Woody Woo — dissented, taking the position that Woody Woo was controlling precedent. He argued that Woody Woo found the statute clear and unambiguous and only imposed a condition on employers using the tip credit. This left no need for the judges to consult legislative history nor any room for DOL to interpret the statute differently. But because two of the three supported the DOL’s position, that regulation is enforceable as the law of the land, at least in the Ninth Circuit (Alaska, Washington, Oregon, California, Montana, Idaho, Nevada, Arizona, Hawai’i and Guam).

Best Practices for Tip Pooling

Where does this leave an employer whose employees receive tips? Here are some good practices to implement — good for compliance, and also likely good for morale.

  1. Do not require or force servers or front-of-house staff to pool tips with back-of-house employees.
  2. If you have a written policy about sharing or collecting tips, make sure it says that pooling is voluntary. (You may make pooling mandatory among front-of-house staff; for example, by requiring servers to share with bussers or hosts/hostesses.)
  3. Better yet, obtain servers’ written acknowledgment that that they choose to participate in the pool and understand it is not required as a condition of employment.
  4. Don’t forget your other obligations with tips. For tax purposes, tips must be tracked (and employees must report cash tips) and income tax withholding applied to tips. 

Automatic (Mandatory) Service Charges

As an alternative to tip pooling, some employers might consider implementing nondiscretionary service charges. Service charges are becoming increasingly common in the restaurant industry, especially in Seattle, given rising minimum wage rates and increasing cost of living. These charges designate a certain percentage of the bill payable directly to employees in addition to their hourly wage. Service charges are permitted by Washington law, as long as you follow certain requirements, including disclosures to customers.  RCW 49.46.160.  As the employer, you may designate what percentage of the fee is paid to front-of-house staff, again as long as you disclose the breakdown to customers.

What About Other Automatic Charges or Fees?

Some restaurants impose automatic charges apart from or in addition to service fees. This might include a large party fee, fees for renting a private room, or a fee to offset increased business costs including minimum wage hikes. These automatic fees are also legal, but the business must make clear to customers that these fees are not substitutes for tips and are not paid directly to employees.   

Best Practices for Automatic Service Charges

If you are using an automatic service charge as an alternative to tipping, (1) notify customers of the service charge on both menus and itemized receipts; (2) indicate that 100% of the charge is paid to employees; and (3) designate how much of the charge is payable directly to the team serving the customer.

If you are using any automatic charges that are not paid directly as tips, (1) itemize the fee as a separate line item from other charges, taxes, and fees on your receipts, (2) identify the charge as a “fee” on itemized receipts, ideally with additional description of the purpose for the fee, and (3) designate what portion, if any, is paid to employees.

If you have specific questions about tip pooling or other wage-and-hour issues, contact Stokes Lawrence Employment attorneys Aviva Kamm or Krista Nelson.

This post provides general information and is not legal advice or opinions on specific facts. 


*Employers in Seattle, Tacoma and Sea-Tac may be required to pay wages as high as $15.24 per hour for 2016 under local ordinances, with wages continuing to increase with inflation.   Return to post.