What Is a Tip Credit? | Formula, Example, & More

What Is a Tip Credit?

If you have tipped employees, you want to make sure you pay them correctly. You might be able to take a tip credit, which lowers the minimum wage you have to pay tipped employees. But, it’s important to use the tip credit correctly to avoid potential lawsuits or penalties.

What is a tip credit?

The Fair Labor Standards Act (FLSA) allows employers to take a tip credit toward the federal minimum wage. This credit means you can pay your tipped employees a lower wage than the federal minimum wage. This lower wage is called a minimum cash wage.

Here’s one way to think about the credit for tips:

minimum wage – tip credit = minimum cash wage

The reason you can take a tip credit is because tip income ideally brings employee wages back up to the federal minimum wage, or even higher.

The current federal minimum wage is $7.25 per hour. The maximum tip credit you can claim is $5.12 per hour. The minimum cash wage is $2.13 per hour.

$7.25 minimum wage – $5.12 tip credit = $2.13 minimum cash wage


Before you can use the credit for tips, you must provide the following information to each tipped employee:

  1. The cash wage you will pay the tipped employee;
  2. The amount you will claim as a tip credit;
  3. That the tip credit you claim cannot be more than the amount of tips the employee receives;
  4. That the employee will retain all of their tips, except if there is a valid tip pooling arrangement in place;
  5. That the tip credit does not apply unless you inform the employee of the tip credit.

You can give the previous information to employees as an oral or written notice. If you do not notify your employees, you cannot use the tipping credit. If you do not give the previous information to employees, you must pay your employees at least minimum wage and employees can keep all tips they receive.

State tip credits

Each state can set its own tip credit amount, just like each state can set its own minimum wage.

Some states don’t have a credit for tips. States without a tip credit include Alaska, California, Minnesota, Montana, Nevada, and Washington. If you have employees in a state without a tip credit, you must pay all employees at least minimum wage, even if they receive tips.

For your state’s minimum wage, tip credit, and cash wage, the U.S. Department of Labor provides a comprehensive table.

If your employees are subject to both federal and state minimum cash wages, you must pay employees the greater of the two cash wages.

What if employees don’t earn enough in tips?

If employee wages don’t reach the minimum wage when you add their tips to their cash wages, you must make up the difference. You must always ensure that your employees make at least minimum wage. To do this, you need to keep good records of how much time employees work, along with the tips they earn.

Patriot’s online payroll software can make your payroll process easier. You can record the tips employees earn. And when you add-on our time & attendance software, employees enter the hours they work, so you don’t have to. Try both for free!

This article was originally published on 5/19/2014.

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