Tip Pooling has become a legal sticky wicket, not simplified by the endless state-by-state variations. Starbucks was recently the unlucky recipient of a $105 million dollar California judgment for purportedly including supervisory staff in their tip pool. Las Vegas casinos have spent the last several years in court defending their tip pooling arrangements. Massachusetts has also become a legal proving ground for these issues, and most recently a New York appellate court ruled that gratuities might no longer be exempt from pooling and sharing rules in certain instances. Much of this problem could also be related to semantics of what is and isn’t considered a tip pool.

Oregon: Specifically prohibits tip pooling, which they define as including all staff, but allows tip sharing.

It is becoming clear that the best way to steer clear of tip related liability is keep two important issues in mind. Never include any supervisor or staff member with supervisory responsibilities in any pool or sharing arrangement, and ensure that all policies that pertain to tips, tip pooling and tip sharing are “recommended” and not mandatory unless specifically approved by your state. For an in-depth discussion of these legal intricacies, please read through Understanding FLSA Tip Credit & Pooling Rules.

What is a Tip Pool? What is Tip Sharing?

Tip pooling is typically the collection of all tips from directly tipped employees so that they may be redistributed among a larger group of employees. Pools are generally considered legal when designed by employees themselves, and with distribution based on the level of service or amount of customer contact.

Massachusetts: Tip-pooling is only allowed where the proceeds are divided among serving staff by proportion to the services given to the patron.

California: Tip-sharing (pooling) arrangements that provide equitable distribution of gratuities among co-employees, even those who did not directly serve a patron, are permissible in California. Just make sure that employers and supervisors do not share in the tip.

Tip Sharing (or tipping-out) differ substantially from tip pooling in that the distribution rates are generally recommended by the employer, and are generally accepted to be incidental to total tips received. These tip-out rates are normally a percentage of tips, sales, or category receipts.

Why Pool?:

Tip pools can be a valuable tool when directly tipped staffs are unable to specifically identify to whom each tip was directed. Examples of ideal pooled tip settings may include retail bakeries, cafés, bars, or casinos where there are multiple services being rendered and single points of payment. Nevada calls this a “service line”.

Certain States have inadvertently increased the incentive to share tips between all staff, in particular California, Oregon and Washington, whose minimum wage is at or above $7.95 per hour, and which do not recognize tips received as a means of meeting their minimum wage requirement. This is called a tip credit. Nearly every other State offers the option to offset cash wages with tips received. Massachusetts, for example, has a minimum wage of $8.00, but requires only $2.63 to be paid in cash. Some States require a written agreement between staff and the employer in order to legally offset minimum wage with tips received.

Washington: Washington state does not recognize tips that employees receive as wages, yet Washinton businesses are required to pay payroll taxes on them. Adjusting this policy would free up limited payroll dollars and has great potential to benefit the back-of-the-house employees. By law, these employees cannot receive tips and have seen their wages fall in recent years.

As an employer, I understand the desire to redistribute a little wealth from one group to another. Is it right for cooks to make the food and a fixed hourly wage, while servers simply deliver it, make the same hourly wage but benefit by keeping all the tips? The present legal environment frowns upon allowing cooks and other secondary staff into a tip pool, but it’s difficult to understand why, when servers are taking home 3-4x the income. Allowing tips to offset wages could avert inequities, but there is a disincentive for states to reverse these laws and give up the increased tax revenues generated.

If there is one small saving grace for employers in these high cash wages States, it is that the Federal Government allows a "FICA Tip Credit" for all tips paid in excess of $5.15/hr. For a servers declaring $10 per hour in tips, their California employers would receive a 36% larger FICA tip credit than their Massachusetts counterparts who are allowed to offset cash wages with tips. Unfortunately this difference only returns about 15% of the additional wages paid.

Practical Tip Pooling Examples:

Imagine that there are three bartenders working at a local pub on Saturday night. There is one register where all sales are rung up, but sales cannot be tracked by employee. These three bartenders place any and all tips into a jar next to the register. At the end of the shift, these bartenders divide the total. This is the clearest example of tip pooling, and it carries with it some important legal details.

It is generally accepted to divide pooled funds up by hours worked

Tip pools are to be defined by the participating staff, not employer

Participation in tip pools is to be strictly voluntary

Employers may recommend tip sharing when not participating in pool

The establishment may demand a written definition of each pool*

The employer may enforce tip pools based on employee definitions*.

The employer may reasonably limit pool redefinitions.

* Certain States

Normally tip pools incorporate and redistribute both the inbound commingled tips as well as the “tip-outs” into the pool definition, especially if portions of these tips are charged. This method however is generally at odds with the FLSA requirement that the participants themselves must create pool definitions.

TipCompliance.com recommends that any tip pooling occur only between those directly tipped employees participating in the pool, and that this pool shall not include any indirectly tipped staff, and certainly no supervisors. Most states confirm it perfectly legal to maintain a subsequent house policy recommending certain staff tip-out other support staff. Therefore, in the bartender scenario, a pool should be created and administered separately from the house recommendations that pool recipients tip-out fellow service providers. Thus pooling becomes an instrument of convenience to the predefined group of directly tipped employees, and not the establishment.

Supervisor: Anyone with the authority to hire or discharge any employee or supervise, direct, or control the acts of cemployees.

Administration of such rules has long been a problem. There are no POS solutions that presently allow and track tip-outs between staff. Therefore most establishments have rolled the pooling and tip-out functions into one – creating a pool that has predefined percentages in it for support staff. It is presently questionable if this methodology would stand up in court. Such a pool setup may or may not have been defined by the directly tipped staff. It is conceivable that such staff, knowing tip out rules could design in tip-out percentages, but it is debatable if such was voluntary, or derived from a mandate or pressure by management. It is far more reliable to maintain a distinct separation between pool policies used to distribute collected funds and that of tip-outs as a means of redistribution.

There is one such product that allows operators all options; GrataSoft Solutions Tip Policy Administration Software. This solution allows either the implementation of traditional pools (including any staff to share in fund pools), the ability to combine directly tipped participant pools and apply tip-outs thereafter, or to simply track and apply inter-employee tip-outs by itself. This is a elegant solution, yet a simple way to navigate the legal quagmire presently working its way through the courts. It is also worth noting that GrataSoft also includes automation of IRS TRAC, ATIP, TRDA, 8027, and allocations processes providing complete tip and wage compliance.

The gaming industry may be best served through a similar two-tier approach to sharing tips. In this hypothetical situation, there might be multiple pools operating simultaneously; Dealers, waiters, bellmen, etc that all are direct recipients of tips. As tokes are turned in, the tip policy system tallies total tips and allocates the pool according to predefined factors – hours worked for example. Each pool may have a different tip-out policy recommended by the house that designates certain amounts be conveyed to specific support staff tasks. These allocations are redistributed to ultimate recipients for cashing out.

Starbucks, like others before it, suggest that in a predominantly retail environment, tips are in recognition of the overall product received, not necessarily the sale service. Starbucks also claims that this is a teambuilding mechanism intended to create a common goal of great service across the entire staff. It could be argued that the person helping you at the register is perhaps the person least responsible for your purchase, but tips conveyed at that time solely due to payment proximity. It has been argued that in such cases, tips may be pooled with all parties involved in that service. Several states have made the distinction for those directly serving the customer and those not. For example, in NY, cooks and dishwashers are not to be included in tip sharing. Also, several states and the Department of Labor have taken exception to tip-out recommendations defined in excess of 15%.

Unfortunately the court makes no distinction between Starbuck’s fast paced retail environment and that of a leisurely restaurant with personal service. What about the small retailer whose manager also works the sales counter? Herein lies the most complex issue regarding tip pooling / sharing. This situation is not unlike the restaurant manager who takes a bar shift.

Nevada: "There is no reason to suppose that the last person in a service line is the only one entitled to share in the customer's bounty," the court wrote. "For example, a busboy as well as a waitress contributes to the good service and well-being of a customer in a restaurant. Similarly, in a casino, the floormen, boxmen and cashiers all contribute to the service rendered to the player."

The law favors discretion in such matters, and continues to guide such supervisory staff not to participate in the pool unless their presence in that post is a regular part of their workweek. The incidental shift is viewed more as part of their responsibility to the house, and thus their wages should reflect these recommendations. If business necessity requires that they take such a shift, the remaining staff should either share in the tips or allow the previously defined sharing plan to prevail. In the case where a manager is a full-time counter staff, there still remains a grey area. Can the balance of the staff actually define the pool with or without this manager’s influence, free from fear of reprisals of guilt? Likely not. It is therefore recommended that these staff not participate in the tip pool creation or it’s distribution.

If employers feel that other staff not in direct customer contact should share in these proceeds, the only sure-fire way is to implement a preset gratuity (service charges are typically owned by the establishment) whose distribution can be defined my management as desired as long as its purpose is made clear to patrons. Gratuities have not had universal appeal as they are typically offensive to non-group customers those in the retail environment.

Oregon: A gratuity is not considered tip income within the control of the regularly tipped employee. A gratuity is a charge that is directly added for services rendered as determined by management, e.g. adding an 18% gratuity for parties over 10 people. This amount is considered wages, and is within the control of the employer, not the employee. Employers may distribute a gratuity at their discretion.

New York: If the employer suggests to customers that the gratuity is to pay the servers for their efforts and that no tips are expected in addition, the New York Appellate Court has ruled that these funds shall be treated as if they were tips and therefore subject to all applicable state tip laws.

In summary, tip pool definitions should be left to the employees to specify, leaving the employer to administer, but participating in no other way. Tip-out policy should be defined to recommend the conveyance of funds to support staff (indirectly tipped), separately and apart from the pool participants whenever possible. Gratuities, when properly utilized, provide an employer with more control of cash distribution.

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.

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