Tip Pooling: Can you legally mandate it in your pizzeria?

tipping, checkLynn’s Paradise Café, a funky and popular eatery for 22 years in Louisville, Kentucky, suddenly closed down in January after employees publicly complained about a tip pooling arrangement. The owner was requiring servers to carry $100 cash at all times to “tip out” coworkers.

Kentucky Jobs for Justice, an organization that advocated for the workers, said at the time that tip pooling was inconvenient for the workers and that the policy violated Kentucky state law. The restaurant countered that tip pooling was for the workers’ benefit, making it easier for them to file taxes and buy into insurance. But after reviewing the very-public complaints, it abruptly served its last meal and shut its doors for good.

Tip pooling is a common practice in which owners collect tips from all employees and redistribute them among the group. While servers like those at Lynn’s Paradise Café are crusading against it nationwide, the National Restaurant Association takes no position on tip pooling. That said, it behooves each restaurant owner to know their individual state’s law on tip pooling before making a business decision on it, says Peter Kilgore, chief legal counsel for the National Restaurant Association. Otherwise, like the folks at Lynn’s Paradise Café, your pizzeria could see problems spiral before you know it.

Before you can understand the legalities and ins and outs of tip pooling, you first have to understand the difference between tips and service charges, Kilgore says.

A tip is a gratuity a customer voluntarily gives in recognition of services performed, Kilgore says. But if the restaurant mandates (on the menu or otherwise) that an “automatic gratuity” of a specified amount will be added to the customer’s bill, that additional amount in law becomes a service charge. With a service charge, the customer’s discretion is eliminated. The customer has an obligation to pay the gratuity, with the legal ramifications that result.

And what are those legal ramifications? Under federal tax laws, the gratuity belongs to the business, not the employee, Kilgore says. “It becomes part of the establishment’s gross receipts for tax purposes and is considered under federal tax laws income to the restaurant; it allows the restaurant, like other gross income, to decide whether to retain the amount itself or give all or part to any employee (not just tip employees), and if the employer does so, the gratuity is treated as wages paid by the employer to any employee to whom it is given,” he says.

However, if the gratuity is deemed to be a service charge, the business can’t use it as a tip credit. And a tip credit enables employers to set a minimum wage for tipped employees. The employees can be paid less than minimum wage by the employer, as long as they receive enough in tips to make up the difference.

Most states that permit a tip credit do allow employer-mandated tip pools, Kilgore says.

What about the legality of tip-pooling? The U.S. Department of Labor has for decades put out guidelines on mandatory employer-imposed tip pools, Kilgore says. They cover:

  • Categories of jobs that will and will not be considered legally eligible for tip pooling.
  • The concept of “customary and reasonable” as to what servers may be required to contribute to the tip pool.
  • The legal approach, and that server permission to participate is not required and may actually be mandated by the employer.
  • Absent any employer involvement, tip employees may decide how to share tips among themselves.

Although the law permits employers to impose mandatory tip pools, you have to decide whether it makes sense both as a business decision and for employee relations, Kilgore says.

One criticism of tip pooling is that servers feel they are subsidizing the work of “slackers” if a tip pool is forced by the employer, says Paul Paz, co-author of “The Professional Server: A Training Manual” and owner of Waitersworld.com. Employee morale is a major consideration if you are trying to prevent turnover, he says.

“Tip pooling is not well received,” Paz says. “If I can deliver that service better than someone else, why not get my credit for it? There’s also the concern they won’t get as many shifts because things have to be divided equally.”

He adds customers develop a psychological connection with their servers, especially the regulars. If you switch to a team service approach to a table –– meaning more than one person waits on it and the tip is pooled –– there is a “disconnect,” he says, because customers don’t really understand who is their server and who deserves the tip.

Kilgore notes, however, that as part of an employer-mandated tip pool, the employer has input into the share each pool recipient will receive.

“Certainly, if an employee participating in an employer-mandated tip pool is not performing the job adequately, the employer may handle the ‘slacker’ as it deems appropriate,” he says. “Employers may also factor in an employee’s work ethic as to the share the employee may receive from an employer-run tip pool.”

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Tracking the Tip Pool

Tip-pool tracking is essential to protect your organization against audits that fall on sample periods chosen by the IRS, says John Marshall. He’s president of GrataSoft Solutions, which has three patents pending on tip reporting software. Marshall is working with Heartland Payment Systems to bring the next generation of tip management to Web, tablet, POS and BYOD platforms.

Say you have three bartenders working a single register. The person who opens the drawer “owns” the tips. “Often, they throw tips in a pot and split it in equal thirds. What’s missing is the reporting side. Whether you’re delivering pizzas or serving at a bar, there’s a lot of cash with no accountability,” Marshall says.

If the bartender gets audited, they would disclose that their tax filing only reflects one-third of the tips in the register. That could ultimately set you up as a target for audit. “The IRS doesn’t care if the tips were shared. The house has deep pockets. So they may say, ‘We’ll go back 60 months and will take a robust month, like December, and that’ll be your sample period. They gouge your eyes out,” Marshall says.

Heidi Lynn Russell specializes in writing about the issues that affect small business owners. She is a regular contributor to Pizza Today and lives in Wilmore, Kentucky.