Understanding Traditional and Nontraditional Tip Pooling
If you operate a restaurant, you’ve likely wrestled with how to fairly compensate back-of-house staff while complying with wage and hour laws. Tip pooling and service charges can help—but each is governed by strict rules that affect your ability to use the tip credit and avoid liability.
Traditional Tip Pools: Tip Credit Means “Limited Participation”
Under the Fair Labor Standards Act (FLSA), your business may take a “tip credit,” which generally permits employers to pay front-of-house staff a reduced minimum wage and to make up the difference with tips.
If you take a tip credit, only employees who customarily and regularly receive tips may be included in a mandatory tip pool. This includes servers, bartenders, bussers, and counter staff—but excludes cooks, dishwashers, and other back-of-house staff. Employers may not retain any portion of pooled tips, nor may tips be distributed to managers or supervisors. A business that includes ineligible employees in a tip pool and takes a tip credit risks legal liability, including being held liable for back pay and penalties.
Including ineligible employees in a tip pool while taking the tip credit can expose your business to significant liability, including back pay and penalties.
Nontraditional Tip Pools: No Tip Credit But More Flexibility
If a business pays all employees the full minimum wage and does not take a tip credit, the business may include back-of-house staff and other employees who do not “customarily and regularly receive tips” in a mandatory tip pool. This means cooks, dishwashers, and other back-of-house staff can share in tips—but only if: (1) the tips are fully redistributed (typically within the same pay period), (2) payroll records clearly identify which employees received tips and how much, and (3) as with a traditional tip pool, employers, managers, and supervisors cannot keep any portion of pooled tips.
“Service Charges” Are Not “Tips”
Some restaurants have moved away from tipping altogether and instead add a “mandatory “service charge” to guest checks. This is legal, but it’s critical to understand that service charges are not tips and are treated differently under wage and consumer protection laws.
A “tip” is a voluntary amount left by a customer for service and is considered the property of the employee. A “service charge,” by contrast (i.e., an automatic 20% added to a bill) is a mandatory fee set by the restaurant and considered business revenue.
If a service charge is distributed to employees, it must be treated as wages—subject to withholding and payroll taxes. However, since it’s not a tip, service charge distributions are not restricted by tip pooling laws and can be shared with any staff, regardless of their role.
Mandatory vs Voluntary Service Charges
Restaurant owners should distinguish between mandatory and voluntary service charges—both require clear disclosures and are not tips.
A mandatory service charge is added to the bill automatically and must be clearly disclosed to customers at the beginning of the ordering process, including on printed or digital menus. Under guidance from the Chicago Department of Business Affairs and Consumer Protection (BACP), the restaurant must also explain how the fee is used, such as to support staff wages or cover operational costs. Importantly, a mandatory service charge cannot be labeled as a “tip” or “gratuity”; doing so may mislead customers and violate consumer protection laws.
A voluntary service charge—such as a 3% “employee benefits” or “health insurance” fee that customers may ask to remove—must also be clearly disclosed. Even though customers can opt out, these charges are still revenue to the business and must not be characterized as tips..
What This Means for Operators
Here’s the bottom line:
- If you take the tip credit, only employees who regularly receive tips may be included in a tip pool.
- If you don’t take the tip credit, you may include back-of-house staff—but must document and distribute tips carefully.
- If you use service charges, they’re not tips. You can distribute them freely, but they must be treated as wages and properly disclosed.
These distinctions may seem technical, but getting them wrong can lead to costly wage claims and penalties. If your compensation model is changing—or hasn’t been reviewed recently—contact the attorneys at Marcus & Boxerman to evaluate your compliance.