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  • Writer's pictureJohn B. Reyna

Tips vs. Service Charges: The Starting Point for many FLSA Violations

My email is constantly bombarded with hospitality employees asking whether their employer handles their tips and service charges correctly. So, I am writing this article to explain how the Fair Labor Standards Act (“FLSA”) characterizes non-hourly compensation through tips and service charges. There is a third form of non-hourly compensation available to some hospitality employees, commissions on goods or services, but that is beyond the scope of this article.

The classification of a restaurant or bar employee's pay determines how and to what extent the compensation satisfies the FLSA's minimum wage or overtime requirements. Thus, ensuring that tips or service charges are classified correctly is paramount.

What is a tip?

The FLSA does not define tip. However, the Department of Labor Regulations provide guidance.

The critical feature of a tip is that the customer solely determines whether a tip is to be given and its amount. A tip is distinct from a payment of a charge, if any, made for the service. A customer presents a tip as a gift or gratuity in recognition of some service performed for the customer.

What is a service charge?

The FLSA does not define service charge. However, the Department of Labor Regulations

provide the following examples of amounts not received as tips:

  • A compulsory service charge (e.g., 15% of the bill) added to a customer's bill is not a tip, even if the employer distributes the amount to its employees.

  • Service charges and other sums that become part of the employer’s gross receipts.

What if managers have the discretion to remove the service charges?

Sometimes, managers remove an automatic gratuity or service charge to satisfy a disgruntled guest or help a server earn a large tip. Does this flexibility and negotiability result in the fees being classified as a tip?

According to two Federal Circuit Courts, no.

The relevant question is whether the customer solely decides to pay the given sum. If the customers cannot determine on their own whether they would pay the service charge, then the fee is not a tip. It is irrelevant that managers may sometimes remove the service charge for dissatisfied customers. Instead, since the managers have the sole discretion to remove a service charge from a customer's bill, the customer cannot solely determine whether to pay the given sum. Again, the material issue is who decides whether and how much to pay.

How does the Department of Labor determine tips vs service charges?

The Department’s Wage and Hour Division’s policy is “to consider all of the facts in assessing whether an amount added to a bill is a tip or a service charge, particularly evidence indicating whether the payment is mandatory or optional, including whether the customer exercises discretion regarding whether the quality of the service merits the payment and the amount of the payment; whether the customers (and/or the recipients of the service) are informed that the payment is optional, and may be increased or decreased at their discretion; and whether in fact there is some variation in the amounts paid. There must be evidence of actual discretion over the fact of and the amount of the payment in order for the amount to be considered a tip and not a service charge. Such evidence may take any form, including a notation on an invoice, a “chit”, a signature on a bill, an email, telephone message, or other notation reflecting directions to adjust the amount of the payment as appropriate.”

Phew, that's a mouthful. But you can see that the DOL focuses on whether the customer exercises discretion regarding whether and how much to pay. That is the ballgame.

Final thoughts.

Determining whether an amount added to a bill is a tip or gratuity is just the tip of the iceberg. Once that determination is made, various provisions of the FLSA will either apply or not. Thus, a misclassification can result in the violation of numerous FLSA provisions. The consequence can be lawsuits for back wages, liquidated damages, attorney's fees, and court costs. On top of that, violators generally lose employees and public favor.

The Texas Hospitality and Non-profit Law Center only provides this material for informational purposes. The firm does not intend for this material to constitute legal advice. Nor does this create a client-attorney relationship between the firm and any recipient.

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