Citing a “significant amount of private litigation,” recent changes in state wage laws, and “independent and serious concerns” of public policy, the U.S. Department of Labor (DOL) is proposing to rescind an Obama-era rule that prohibits employers from implementing tip-sharing pools comprised of both tipped and non-tipped employees.

Last week, the DOL published a Notice of proposed rulemaking (NPRM) that would scale back the tip-pool regulations under the Fair Labor Standards Act (FLSA) and allow employers to include more employees in its tip-sharing pools. Under the new proposed regulations, if an employer pays its employees an amount equal or greater to the minimum wage without utilizing the tip credit provision found in Section 3(m), then the employer would no longer be bound to Section 3(m)’s prohibitions on tip-sharing amongst traditionally non-tipped employees. Instead, the new rule would allow employers to expand their tip sharing pools to include employees who are not customarily tipped, such as dishwashers and restaurant cooks, but who “contribute to the customers’ experience.”

Congress Amended Section 3(m) of the FLSA to Allow Employers to “Credit” to Their Minimum Wage Obligations Tips Paid to Employees.

The FLSA generally requires covered employers to pay its employees a federal minimum wage of at least $7.25/hour. In 1966, Congress amended Section 3(m) of the statute, defining the term “wage” to include a provision that permitted an employer to utilize tips received by employees to subsidize up to 50 percent of its minimum wage obligations. In other words, an employer could use the amount of tips an employee receives as a partial credit to satisfy the difference between the statutorily required minimum wage and the direct wages paid to the employee.

Congress again amended Section 3(m) in 1974 to further limit when an employer could credit an employee’s tips to its minimum wages obligations. Specifically, the 1974 amendment provided that employee tips could be credited to the employees' wages only if the tipped employees were allowed to retain all of their tips. Congress included a specific carve-out, however, that allowed employers to still use the tip credit in instances where the employer required employees to deposit their tips into a tip pool shared only among those employees who “customarily and regularly” received tips.

Despite this significant amendment to the tip credit provision, it took the DOL nearly 40 years to revise its regulations to reflect and address the 1974 amendments to the FLSA’s tip-credit provision.

Under the DOL’s 2011 Rules on Tipping, All Employers, Regardless of Whether They Utilize Section 3(m)’s Tip Credit, Are Prohibited From Including Nontipped Employees in Tip-Sharing Pools.

In 2011 the DOL issued a Final Rule addressing tip pooling, the tip credit, and other regulations pertaining to other permissible uses of employee tips. In pertinent part, the 2011 Final Rule stated: “The employer is prohibited from using an employee’s tips, whether or not it has taken a tip credit, for any reason other than that which is statutorily permitted in section 3(m): As a credit against its minimum wage obligations to the employee, or in furtherance of a valid tip pool.”

These regulations barred all employers from implementing tip-sharing pools that included employees who did not customarily and regularly receive tips, regardless of whether or not the employer was utilizing Section 3(m)’s tip credit for purposes of satisfying its minimum wage obligations. In other words, an employer was still bound by Section 3(m) limitations on tip-sharing pools even if that employer paid its employees above minimum wage without applying a tip credit.

Since the passing of the regulations, employers have not been prohibited from maintaining tip-sharing pools among traditionally tipped employees such as servers and bartenders. However, the regulations have prohibited other employees like cooks and dishwashers from being included in and receiving pay from these tip pools.

Increased Litigation Over the Application and Validity of the Tip Sharing Regulations Raised “Serious Concerns” at the DOL About the Blanket Application of the 2011 Final Rule to All Employers.

The 2011 regulations faced almost immediate scrutiny from employers throughout the hospitality industry. These employers challenged the DOL’s authority to promulgate the 2011 Final Rule, asserting that the rule was contrary to the FLSA’s clear statutory language in Section 3(m) that placed restrictions on an employer’s use of tips only when the employer used the tip credit to meet its minimum wage obligations. Accordingly, there was an increase in litigation addressing the validity and implementation of the 2011 Final Rule, resulting in a split between the Ninth Circuit and the Tenth and Fourth Circuits.

The Ninth Circuit, in ORLA v. Perez, 816 F.3d 1080 (9th Cir. 2016), granted the DOL’s appeal of the district court’s decision that the regulations were contrary to the clear intent of Congress, and upheld the validity of the tip regulations. The Ninth Circuit consolidated the case with Cesarz v. Wynn Las Vegas, 2014 WL 117579 (D. Nev. 2014), a private FLSA action in which the plaintiffs-employees relied on the 2011 regulations to assert that the employer violated the FLSA when it required its casino dealers to share their tips with other employees who did not receive tips. Having found that the FLSA was silent with respect to employers that do not take a tip credit, the Ninth Circuit concluded that the tip regulations were a reasonable application of the agency’s authority to fill gaps left in the text of the FLSA. Notably, a dissent opinion joined by 10 judges asserted that the agency did exceed its authority because the DOL “has not been delegated authority to ban tip pooling by employers who forgo the tip credit….” Both parties in the ORLA matter filed a petition for certiorari with the Supreme Court that is still pending.

While ORLA was pending, the Fourth Circuit heard Trejo v. Ryman Hospitality Properties, Inc., 795 F.3d 442 (4th Cir. 2015), a private FLSA action brought by restaurant and hotel servers who were required to share their tips with bartenders, server assistants, busboys, and food runners. The DOL submitted a brief as amicus curiae arguing that the 2011 regulations were valid and entitled to deference. Disagreeing, the Fourth Circuit concluded that Section 3(m) “simply does not contemplate a claim for wages other than minimum wage or overtime wages.” Trejo, 795 F.3d at 448.

Likewise, the Tenth Circuit ruled in Marlow v. The New Food Guy, 861 F.3d 1157 (10th Cir. 2017) that the 2011 tip regulations were invalid to the extent they barred and employer from sharing tips with employees who did not customarily or regularly receive tips when the employer paid wages that satisfied the minimum wage laws without claiming a Section 3(m) tip credit.

According to the DOL, the Marlow decision and the dissent in ORLA raised “serious concerns” over whether or not it had correctly construed the statute when promulgating its 2011 regulations on tip sharing.

The DOL also noted that the high volume of litigation involving the 2011 tip regulations had been further exacerbated by the fact that after 2011 a number of states, including as Arizona Colorado, Minnesota, and New York, amended their wage laws to increase the amount of wages an employer must pay tipped employees without utilizing a tip credit. As a result, the number of employers utilizing Section 3(m)’s tip credit to satisfy its minimum wage obligations has decreased significantly over the past five years.

The DOL’s New Rule Is Limited Only to Those Employers That Pay Employees the Full Minimum Wage Without a Tip Credit.

Although the DOL ceased enforcing the 2011 tip sharing regulations in July of this year, it is now seeking to formally rescind certain parts of its prohibition against the sharing of tips with employees who do not customarily receive tips. The DOL made clear, however, that the proposed rule would only apply to employers that pay employees wages of at least the federal minimum wage and do not take a tip credit. The new rule would not apply to employers that pay less than the federal minimum wage and still take advantage of Rule 3(m)’s tip credit provision. “The purpose of section 3(m)’s tip credit provision is to allow an employer to subsidize a portion of its Federal minimum wage obligation by crediting the tips customers give to employees. If an employer takes a credit against its wage obligations, section 3(m) applies, along with its attendant protections that restrict the employer’s use of tips received by its employees.”

The DOL Expects the New Rule Will Have Positive Effects on Employers and Employees Alike.

Touting “greater flexibility” in establishing pay practices for tipped and non-tipped workers, the DOL surmises that this new proposed rule could result in a number of benefits in the workplace such as:

  • A reduction in wage disparities between employees who traditionally have received tips and those employees who are in lower-wage job classifications and do not typically receive tips;
  • An increased incentive among all employees to improve service quality and customer’s experience regardless of their position or role;
  • Increased interaction and cooperation between coworkers;
  • An increase in employee productivity;
  • A decrease in employee turnover;
  • Employers in other industries (e.g. casinos) could adopt similar tip pooling arrangements; and
  • Clarity and consistent application of Rule 3(m)’s tip-sharing requirements across the country.

Nevertheless, the DOL acknowledged that the extent of these potential benefits and the effect of the proposed rule on traditionally nontipped employees is entirely dependent on a number of unmeasurable market forces.

Public Comments Sought on Employer Tip-Sharing Procedures and Potential Responses to the Implementation of the Rule

Because it is unable to quantify the effect the regulation may have on employer, employee and even consumer behaviors, the DOL is seeking public feedback on the proposed regulation and the potential effect its implementation would have on employer tipping procedures and consumer tipping practices. Specifically, the DOL has requested public comments and information on the following issues:

  • For those employers that pay their tipped employees wages equal or greater to the minimum wage and do not utilize the tip credit, what portion of those employers reallocate tips among other employees, and what portion of the total tips do they retain and reallocate?
  • 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 will be 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?
  • Do tipped employees who are required to participate in a mandatory tip pool 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?
  • If this proposed rule were adopted, what types or categories of employees would employers choose to include in mandatory tip pools?
  • What effect would the proposed rule have on customers’ tipping practices?
  • If the rule were adopted, would employers expand tip pools and reallocate tips to nontipped employees and, if so, what effect would this have on the disparity between the take-home earnings of tipped and nontipped employees in the service industry?
  • If this rule were adopted as proposed, what nonregulatory limitations would employers and employees face when deciding whether and how to design a tip-pooling arrangement?
  • What market norms or other behavioral or cultural reasons cause certain types of tip pooling to be 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 originally requested that all comments be received on or before January 4, 2018. However, the DOL has now indicated on its website that it will be extending this comment period by an extra 30 days. BakerHostetler’s Employment Group is available to assist in the preparation and drafting of any comments for submission to the DOL on this matter.