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GrataSoft™ Solutions turn tip compliance into strategic advantage - minimizing tip tracking and IRS tip program administration while minimizing audit downside.

John Marshall
EAT, Inc, PO Box 144
5 Crescent Ave, Bld G
Rocky Hill, NJ 08553
tel: 609.786.1004
fax: 609.921.7067

Patent Pending tools and processes, which increase value through enhanced operational compliance and material reductions in administrative burden.

Tip-Out tracking: wage & hour class action repellent?

By John Marshall

There are high profile class action lawsuits all over the news these days.  Starbucks led the way, followed by many copycats in states all across the country.  That said, it’s hard for individual operators to imagine themselves in such hot water, but watch out, there is a trend spreading and it’s likely coming to a town near you.

New York City seems to be a current hotbed of activity, and it’s not hard to see why.  States that allow establishments to pay workers cash wages below minimum wage are prone to these suits.  The second reason is that state minimum wages have dramatically increased recently, most exceeding the federal minimum wage.

Presently New York State allows restaurant workers to be paid as little as $4.60 per hour in cash, but many other states still allow $2.13 minimum cash wage.  These rates are derived from the Federal regulations (DOJ FLSA) that allow for reduced cash wages provided that an individual’s tips combined with cash wage meet or exceed the regular minimum wage (Presently $7.15 in New York).

Most operators pay little or no attention to these numbers, as most know that all staff typically take home wages and tips that exceed minimum wage.  The devil is in the details however.  What an operator knows, and what one can prove are sometimes light years apart.  Can a restaurant operator prove and document that each and every employee has received tips meeting or exceeding the current minimum wage?  Obviously not, indicated by the number of suits and settlements to date.

So what is an operator to do?  Typically, servers are the most plentiful, lowest paid, and easiest group of employees to validate against minimum wage.  There is likely no shortage of credit card receipts that can be used to prove that these employees meet the regulations.  What about the indirectly tipped employees?  These are the staff that typically support the front line wait staff, but receive their cash tip-outs from servers at the end of the shift.  The problem lies in these undocumented and undeclared tip-outs.

Under the Department of Justice FLSA, the provision for employers in participating state to lower cash wages is available provided that each and every staff member’s (that’s right – ALL) cash wages plus tips meet or exceed the minimum wage.  Restated, it has been successfully argued that if just one individual misses that mark, the entire FLSA wage provision is rendered null, and ALL STAFF must be paid minimum wage in cash.  This is the fly in the ointment, because all of those safe and reliable credit card vouchers proving servers met minimums are no longer of any use once the provision is void.

Liability Exposure Example:

A New Jersey restaurant has sales of 1.0 million and its servers tip-out 3% of their sales equally to bussers and service bartenders.  The indirectly tipped staff has not declared any cash tips received in this pay period.  NJ minimum wage is $7.15.

            Job         Cash Wage  Total Hours   Tips Declared

            Server             2.13                 320                  12%

            Svc Bar           5.50                    80                   0

            Busser            4.25                  100                   0

When no tip-outs are reported:

            Tips are 25% low - IRS Penalty of $2295 + Interest x 5 years

            Employer may be funding wage shortfall of $10,972 annually.

When employer does not fund wage shortfall, tip credit fails:

            Employer may owe $52,728 annual back wages x 5 years

            Tips remain 25% low - IRS Penalty of $2295 + Interest x 5 years

It is also worth noting that some states have begun to adopt penalties for wage and hour violations multiple times larger than the actual shortfall.  Massachusetts is one such state that recently approved triple damages.  You can be sure that this will be an active incentive for class action going forward.

There is only one means of ensuring that you operation is protected from a tip credit provision failing:  Track all tip-outs in your establishment.  That’s right.  Unless you have the unique staff that personally and accurately report their tips and tip-outs to you, then you must do it for yourself.

Good payroll providers in some instances will “pay” the shortfall between wages plus tips reported as necessary to meet minimum wage.  If you have such a provider, consider yourself lucky, but you are paying a huge price.  If all of those cash tips have in fact been exchanged between staff but gone unreported, then you are paying your staff twice!

Tip-out tracking can be a far more profitable task than one might first imagine.  Assuming that your indirectly tipped staff are paid cash wages three dollars an hour less than minimum wage, declare no tips, and they rack up 160 hours per week in total, you just might be shelling out an extra $25,000 annually to close the shortfall.

There is a secondary financial benefit to tracking tip-outs on top of eliminating gap funding.  It is the Social Security Tip Credit.  Simply stated, it allows an operator to enjoy a dollar-for-dollar tax credit for all FICA tax paid on employee tips declared in excess of Federal Minimum wage (frozen at $5.15).  Using the example above, and assuming that the tip-outs exactly met and did not exceed New York minimum wage, the operator would enjoy a $1260 credit on her end of year tax bill.  Since you don’t pay the employee tips (the customer does), for every $13 increase in additional tips declared, the IRS takes $1 off of your taxes owed.

When using the FLSA tip credit to pay reduced cash wages, make sure that you or your payroll provider is calculating overtime properly.  It is not 1.5 times the base cash rate; it is 1.5 times the full minimum wage rate, less the tip credit amount.  For example, a common mistake it to assume that a base rate of $4.60 x 1.5 = $6.90 is the appropriate overtime rate for tipped employees.  It is not.  The proper calculation is $7.15 x 1.5 = 10.73 less the state tip credit (7.15 – 4.60 = 2.55), or an overtime rate of $8.18 per hour for tipped employees.

As long as we are picking on New York, that state has a "spread of hours" provision.  The regulation provides an extra hour of pay to workers putting in split shifts longer than 10 hours.  In other words, if one were to work a single hour at 8 AM, and another single hour at 6 PM, that employee would be due the two hours worked, plus an additional hour due to the spread.  This could be used as another popular trap when scrutinizing the tip credit.  Although it has been tested when excess cover the hour, it is always prudent to err on the side of caution and make sure cash wages do as well.

In closing, there are potentially valuable financial benefits for the operator who adopts tip-out tracking as one means of closing potential wage and hour loopholes.  Exposure to audit is high and downside can be substantial, and is likely to grow.  Once one knows how all the pieces to the puzzle fit together, one can close or limit vulnerabilities, while simultaneously turning these liabilities into financial benefits for the organization.

Mr. Marshall is the owner of Main Street Gourmet Eatery and Bakery, Main Street Fine Catering, and Main Street Euro-American Bistro and Bar. He is president of GrataSoft Solutions, developer and publisher of Grata Restrateur and Grata Persona; patent pending solutions for implementing, tracking and managing tip policy, including IRS TRAC, TRDA and EmTRAC Tip Program compliance automation for businesses and individuals. For more information, please visit GrataSoft.com.