Tip Credit

A tip credit is the portion of a tipped employee's minimum wage that an employer covers with the employee's tips instead of its own payroll. The employer pays a lower cash wage, and tips fill the gap up to the minimum wage.

A tip credit does not let employers underpay. If tips and cash wages fall short of the minimum wage in a workweek, the employer must make up the difference.

How Does a Tip Credit Work?

Federal law requires a cash wage of at least $2.13 per hour for tipped workers. The employer can claim a credit of up to $5.12 per hour, which is the gap to the $7.25 federal minimum wage.

The credit can never exceed tips actually received. Each workweek, cash wages plus tips must reach the full minimum wage, or the employer owes the difference.

Example: a server works 40 hours at $2.13, earning $85.20, and receives $150 in tips. That totals $235.20 against the $290 minimum for 40 hours at $7.25, so the employer owes $54.80.

Who Is a Tipped Employee?

A tipped employee customarily and regularly receives more than $30 a month in tips. Tipped employees still earn overtime, as non-exempt employees do.

In dual jobs, a hotel maintenance worker who also serves is tipped only for server hours. Side work inside the tipped job, such as setting tables, still qualifies.

A court vacated DOL's 2021 revision of this rule, often called the 80/20 rule, and the original regulation is back. Confirm whether your state adds limits.

What Notice Must Employers Give?

Before taking the credit, an employer must give five points of notice, including the cash wage, the credit amount, and that employees keep all tips except in a valid tip pool.

Notice can be oral or written. An employer that skips it cannot take the credit and must pay the full minimum wage in cash.

How Do State Rules Change the Tip Credit?

When state and federal law differ, employers must follow the standard most protective of employees. DOL's tipped wage table, revised July 1, 2026, lists Alaska, California, Minnesota, Nevada, Oregon and Washington as requiring full state minimum wage before tips.

Other states set a higher cash wage than $2.13, including Colorado at $12.14 and Illinois at $9.00. Cities can set higher rates, so check state and local HR compliance requirements.

What Mistakes Break Tip Credit Rules?

Three of the typical problems DOL lists are easy to miss in payroll, and each one can leave a tipped employee underpaid.

• Calculating overtime from the $2.13 cash wage instead of $7.25. See straight time versus overtime pay.
• Deducting walkouts, breakage or register shortages from pay.
• Missing the shortfall deadline, which is the regular payday for the period in which the workweek ends.

Review each employee's hours, cash wage and tips every workweek before payroll closes, using accurate worker time tracking.

How Does HR Cloud Help With Tip Credit Compliance?

Tip credit math runs one workweek at a time, so accurate hours come first. HR Cloud's time tracking software lets employees enter time in the platform or on a mobile device, and reports support audits and record keeping.

HR Cloud's pages do not describe tip credit calculation, so keep that in payroll. See HR software for hospitality or request a demo.

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Frequently Asked Questions

Q: Is a tip credit the same as the FICA tip credit?

A: No. The FICA tip credit is an employer tax credit, claimed on IRS Form 8846, for Social Security and Medicare taxes paid on tips. It does not change wages.

Q: What records must employers keep?

A: Employers must record tipped employees, reported tips, the credit claimed, and hours worked in tipped and non-tipped occupations, per Fact Sheet #15.

Q: Can an employer deduct credit card fees from tips?

A: Only the card company's actual fee, and never below minimum wage with the credit counted. Some states bar the deduction entirely.

Q: What counts as a tip?

A: Cash, checks and amounts customers add to card bills count as tips. Gifts such as theater tickets or merchandise do not.

Q: Can tips alone count as a worker's whole pay?

A: No. The employer must pay a cash wage of at least $2.13 per hour with credit conditions met, or the full $7.25.

Q: Is a new server tipped because coworkers earn tips?

A: No. Each employee must personally receive more than $30 a month in tips; a group's record does not qualify a new hire.