The U.S. Department of Labor (DOL) has issued a proposed rule to rescind the Department’s position that employers must comply with tip-pooling requirements even when paying the full minimum wage. This proposal, if finalized, would allow employers that pay employees at least the full federal minimum wage to require employees to share tips with employees who are not otherwise customarily tipped, such as cooks, dishwashers, porters and maintenance staff. This rule would not affect employers that apply a tip credit towards employees’ wages.

Background

In 1966, Congress enacted an amendment to the federal Fair Labor Standards Act (FLSA) that permitted employers to utilize tips received by employees as a credit against part of the employer’s minimum wage obligations. In 1974, Congress passed another amendment to the FLSA that conditioned an employer’s ability to use this “tip credit” by requiring that an employer inform its employees of the provisions of the FLSA’s tip credit provision and requiring that employees retain all tips, except that tip pooling among customarily and regularly tipped employees was permitted.

In 2011, the DOL amended FLSA regulations to reflect its view at the time that the tip-pooling requirements apply to all employees receiving tips, even if the employer paid an employee at or above minimum wage, and did not take a tip credit against the minimum wage paid to employees. On December 4, 2017, the DOL published a Notice of Proposed Rule Making (NPRM) that would rescind these portions of the 2011 tip regulations.

New Proposed Rule

The DOL noted that it was motivated by several factors to issue the NPRM. First and foremost, the DOL believes it is not authorized to issue a regulation that affects employers that do not apply a tip credit, and therefore acted beyond its authority in promulgating the 2011 regulation. Indeed, the DOL stated, “[t]he Department has serious concerns that it incorrectly construed the [FLSA] in promulgating its current regulations, the scope of which extends to employers that have paid the full Federal minimum wage to their tipped employees, particularly insofar as those employers, rather than taking tips for their own purposes, provide for such tips to be shared with other employees through a tip pool.”

Second, the DOL indicated that a motivating factor behind the NPRM was to provide clarity for the significant amount of private litigation involving assertions of improper tip pooling and tip-retention practices of employers that pay a direct cash wage of at least the federal minimum wage and do not take a tip credit.1 In addition to the increase in litigation, the DOL noted that in 2011, when it promulgated its most recent tip-pooling regulations, approximately 17% of the states had laws that required employers to pay employees a direct cash wage that exceeded the full federal minimum wage. As of December 2017, that number has almost doubled and approximately 31% of the states require employers to pay employees a direct cash wage that exceeds the full federal minimum wage. In light of this “changed landscape and extensive litigation,” the DOL found it incumbent to issue a retraction of a regulation it now deems to improperly construe the FLSA.

The DOL is inviting the public to submit comments, which should include supporting data whenever possible, on the proposed rescission of the 2011 tip regulations that apply to employers that pay tipped employees a direct cash wage that is equal to or in excess of the federal minimum wage and that do not claim a tip credit. Specifically, the DOL has solicited feedback regarding the following issues:

  1. Among employers that currently pay a direct cash wage of at least the federal minimum wage and do not take a tip credit, what portion reallocate tips with other employees? And, among that population of employers, what portion of the total tips do they retain or reallocate?
  2. How prevalent are employer-required, or mandatory, tip pools? What factors determine whether an employer institutes a mandatory tip pool? What portion of the tips received by employees do employers anticipate being contributed to the tip pool? What kinds of factors might influence an employer’s decision to exclude some tips from inclusion in a mandatory tip pool?
  3. Do tipped employees receiving money from a mandatory tip pool typically receive a fixed dollar amount, or a fixed percentage of the pool? Is it common for some employees to receive a larger share of the tip pool than others, or are tips typically distributed on an even basis among all participants in the tip pool?
  4. If this proposed rule were adopted as proposed, what kinds of employees would employers choose to include in mandatory tip pools?
  5. If this proposed rule were adopted as proposed, would customers’ tipping practices change?
  6. If this proposed rule were adopted as proposed, would some employers respond by reallocating tipped income to their non-tipped employees? Would such a response reduce the disparity in take-home earnings between tipped and non-tipped employees in service industry establishments?
  7. If this rule were adopted as proposed, what non-regulatory limitations would employers and employees face when deciding whether and how to design a tip-pooling arrangement? Are there any market norms or other behavioral reasons why some types of tip pooling are more prevalent than others? To what extent is the endowment effect (that is, customarily and regularly tipped employees potentially valuing tips more than wages of the same average amount) relevant for explaining potential tip behavior in a relatively less-regulated market?

The DOL also recognized that if employers decide to pay the full FLSA minimum wage without applying a tip credit, they may have cost savings, because they will no longer need to keep the specific records required under 29 CFR 516.28. On the other hand, the DOL recognized that some employers that choose to change their practices and pay at least the full FLSA minimum wage in cash and not apply a tip credit may incur costs related to revising their employee handbooks, adjusting their payroll systems, and advising affected employees. Accordingly, the DOL has also solicited feedback to ascertain the cost-benefit thought process employers would undergo if the DOL rescinds the 2011 rule.

Next Steps

Comments in response to the NPRM are due by January 4, 2018. In the meantime, employers in states that follow the FLSA should consider the pros and cons of eliminating the tip credit. In particular, employers should start evaluating whether they can withstand the payroll cost increase from raising front-of-house staff wages to the full federal minimum wage rate and simultaneously lowering back-of-house and other non-regularly tipped employees’ wage rates and by offsetting that reduction by allowing these employees to participate in a tip pool.

One word of caution: Several states, such as New York, have implemented laws and regulations that outright prohibit the sharing of tips with employees who are not primarily engaged in guest service. The NPRM will have little effect on employers in these states, so as always, check whether any state of local laws contain more stringent prohibitions.