The U.S. Court of Appeals for the Fifth Circuit concluded on June 14, 2016 that an employer may not deduct more than the actual credit card fees associated with liquidated credit card tips for employees without compromising the tip credit taken by the employer against the employee’s wages. Steele v. Leasing Enterprises, Ltd., No. 15, 20139 is an important decision for employers with operations in the Fifth Circuit because it endorses for the first time other courts’ conclusions that certain deductions may be made against an employee’s tips by an employer without disturbing the tip credit, but illustrates the danger in overreaching in those deductions.

The Fair Labor Standards Act (FLSA) permits an employer to pay a tipped employee up to $5.12 less than the minimum wage—called the tip credit—so long as the employer complies with all of the relevant provisions associated with taking the tip credit, including notice, ensuring an employee always earns enough to cover the minimum wage, and that the employee is entitled to keep all of his received tips, absent a valid tip pool. Courts and the Department of Labor (DOL), however, have long allowed for an exception related to credit card fees.

In Myers v. Copper Cellar Corp., 192 F.3d 546 (6th Cir. 1999), one of the leading credit card tip fee cases, the Sixth Circuit held that an employer may subtract a sum from an employee’s charged gratuities if that sum reasonably compensates the employer for its outlays sustained in clearing the tip through a credit card processing company. The Sixth Circuit noted that while some deductions may exceed the expense incurred, the employer need only prove that, in the aggregate, the amounts collected from its employees over a definable time period have reasonably reimbursed the employer for no more than its total expenditures associated with the credit card tip collections.

In the Steele matter, however, the employer’s 3.25% deduction from the credit card tips always exceeded the actual charges incurred by the employer in liquidating the credit card tips through a processing company (in one year the total aggregate, annual overpayment for the entire restaurant was $7,500). The employer attempted to argue that other charges, such as the cost of the company to have cash on hand to process the credit card tips on a daily basis, should be allowed. The Fifth Circuit made clear, however, that employers are not required to liquidate credit card tips on a daily basis, and that the regulations permit the settling of tips on a pay period by pay period basis. Because the cost of having cash on hand was not a fee directly attributable to its required cost of dealing in credit, and instead were internal business decisions related to employee demand and security issues, charging the employee for the costs of cash deliveries for liquidating tips violated the FLSA’s tip credit provisions.

The result of this narrow error, according to the Fifth Circuit, was that the employer could not take advantage of the tip credit at all. Presumably, this would mean that the employer could owe up to $5.12 per hour for every work hour for each tipped employee who was over charged the credit card processing fee. The Fifth Circuit’s endorsement of this windfall is a stark reminder that employers should be very cautious when deducting any amount from an employee’s tips.