Here’s a Tip on Tips

This is the first tax year where the newly passed legislation has allowed tipped employees to take a deduction from their wages for the tips that they received in their employment in the previous year – the famous “no tax on tips” law.  The introduction of that new tax treatment of tips did not go as smoothly as one would hope, given that employees who receive tips as part of their typical wages and had them reported on their W-2 forms and paid taxes on those tips.  In order to benefit from the no tax on tips promise, employees had to take a deduction for the tips they received and then receive a refund on their annual tax return.  This complication related to tips should be no surprise to employers or employees, as the wage and hour laws have always treated tips differently from regular wages. 

Tipped employees are subject to a different – and much lower – minimum wage depending both on the federal and state laws in effect.  The minimum wage for tipped employees varies from state to state, with some states allowing tipped employees to be paid a minimum wage of $2.13 per hour (the federal requirement) while others require tipped employees to be paid the regular minimum wage.  For those states where employees are entitled to a lower minimum wage, employers are given a “tip credit” which is designed to cover the difference, if there is one, between the state’s minimum wage and the tipped employee wage – essentially having customers who pay the tips be responsible for ensuring that servers and other tipped employees receive the statutory minimum wage for their labor. 

In order for an employer to be eligible to take the tip credit, certain requirements must be met in how tips are collected and disbursed among employees. A recent court decision in Texas, Paschal et al v. Perry’s Restaurants Ltd. et al, Case Number:1:22-cv-00027 (March 24, 2026), addressed the impact of a tip pool on an employer’s ability to take such a tip credit.  That case involved a claim by servers at a large steakhouse chain who claimed that the restaurant forced them to participate in a tip pooling arrangement that included employees who were not in tip eligible positions.  In addition to suing the restaurant chain, the plaintiffs also sued the owner personally.  Under the tip pooling arrangement at Perry’s, employees were required to remit 4.5% of their total sales each week to a mandatory pool.  Funds in that pool were then distributed to other staff members who were not involved in customer service roles.  Some of the recipients of tip pool funds worked before the restaurant was open to the public, thus establishing that their roles were not customer facing. 

After a bench trial, the Western District of Texas Austin Division issued a decision finding that Perry’s violated the Fair Labor Standards Act by distributing mandatory tip pool funds to employees who did not customarily and regularly receive tips.  The court further determined that, because the defendants failed to demonstrate that those employees were tip eligible, the entire tip pool was unlawful and the company could not claim the tip credit generally available to employers of tipped employees.  The court further found that the violations of the law were willful, based on the defendant’s knowledge of the FLSA requirements based on prior litigation involving the company.  The willful violation determination extended the statute of limitations period from two to three years, increasing the potential amount of damages incurred by the class of plaintiffs. The judge entered a $21 million dollar judgment in favor of 707 opt in plaintiffs.  The judgment was entered against both the company and Perry, the owner, jointly and severally.  The amount awarded represented unpaid minimum wages, liquidated damages, misappropriated tips, and the employer’s share of unpaid FICA tax. 

This case highlights the need for employers to ensure that they are both knowledgeable and compliant with the wage and hour laws, as violations of these laws can be very expensive.  The court issued liquidated damages in this case based on the determination that the violation was willful – and this determination was based on the company’s persistent violations of the law.  Personal liability was attached to the owner because of the control that he exercised over the company and over the decision to maintain the tip pool practices despite other claims that had been made regarding violations.  In this case, the tip pool rules are fairly well understood, but employers face pressure from non-tip receiving employees to allow them to participate in the tip pools.  While it seems like making these pools more inclusive would be good for employee morale, that consideration cannot override the terms of the law – particularly where the employer stands to benefit economically from expanding the tip pool. 

Employee compensation and benefits are complex and highly regulated.  myHRcounsel can assist employers in developing compensation and benefit plans that are legally compliant and motivating to employees.