Tip credit is a federal/state wage provision allowing employers of tipped employees to pay a base hourly rate below standard minimum wage, provided tips raise total compensation to or above standard minimum.
Federal tipped minimum: $2.13/hour. Federal standard minimum: $7.25/hour. Maximum tip credit: $5.12/hour. Tipped employee must average at least $7.25/hour total comp (tips + base) over the workweek.
Federal vs state tip credit rules
Tip credit is governed by the federal Fair Labor Standards Act (FLSA), but states are free to set higher floors:
- Texas: defaults to federal — $2.13/hour tipped minimum, $7.25/hour standard minimum.
- States with significant tip-credit restrictions: California, Washington, Oregon, Alaska, Montana prohibit tip credit entirely (full standard minimum for all hours). Nevada and Minnesota apply partial restrictions that depend on employer category — Nevada by whether qualifying health insurance is offered, Minnesota by gross-receipts threshold. Verify your state's specific rules before relying on the tip credit.
- Washington DC is phasing out tip credit via Initiative 82, with staggered increases through 2027 bringing the tipped minimum to DC's full standard minimum.
- States with intermediate tipped minimums: roughly half the states have tipped minimums above $2.13 but below their standard minimum. Check your state's labor department site for current numbers — they update annually.
How the math works
Example, Texas-typical: a server works 30 hours in a week at the $2.13 tipped minimum. Base pay = $63.90. The server reports $480 in tips. Total weekly comp = $543.90, or $18.13/hour effective. Compliant — well above the $7.25 standard minimum.
If the same server worked a slow week with only $90 in tips: $63.90 + $90 = $153.90, or $5.13/hour. Below the $7.25 standard minimum. The employer is required to make up the difference: 30 hours × ($7.25 − $5.13) = $63.60 owed in addition to base pay. This is the "make-whole" obligation that operators must track and pay.
What employers must do to claim the tip credit
Federal law requires:
- Notify employees in advance (in writing) that the tip credit will be used, and explain the math.
- Verify weekly that tips + base = at least standard minimum × hours. Make-whole if short.
- Don't take tips for the employer. Tips are property of the employee. Employer-mandated tip pools that include non-tipped employees (managers, BOH in some jurisdictions) can void the tip credit and trigger back-pay liability for the entire pay period.
- Track the 80/20 rule: tipped employees can spend up to 20% of their time on non-tipped duties (rolling silverware, sweeping, etc.) while still claiming the tipped wage. Above 20% directly-supporting work, or any time on non-tip-producing work, must be paid at full standard minimum.
Why this is the most-audited area of restaurant payroll
The Department of Labor's Wage & Hour Division (WHD) audits tip credit compliance heavily. Common violations:
- Employer not informing employees of tip credit in writing
- Tip pools including managers or non-tipped staff
- Failure to make-whole on short tip weeks
- 80/20 violations on side-work time
- Tracking tips as cash without proper records
Settlement amounts on tip-credit DOL cases routinely run $50K–$500K for independent restaurants, and back-pay liability extends two years (three if willful). Operators in tip-credit states should run a payroll-compliance audit annually.
Common operator mistakes
- Including managers in tip pools. Federal rule: managers cannot be tip-pool participants. Period. Voids the tip credit and triggers back-pay.
- Not tracking make-whole hours. Slow weeks happen; if you don't make-whole, you owe it later with interest and penalties.
- Verbal-only tip-credit notice. Federal rule requires written notice. Verbal-only fails the disclosure test.
- Confusing tip credit with tipped minimum wage. Tip credit is the dollars; tipped minimum is the resulting base rate. Operators sometimes describe their pay structure incorrectly to employees, then have to defend the math in an audit.
Related concepts
- Labor cost percentage — tip credit lowers FOH base pay but doesn't change the operational labor metric (since tips aren't on the P&L)
- FOH / BOH — tip credit applies to FOH only
- Turnover rate — pay structure clarity reduces turnover; payroll disputes drive it up