Tipped Employee Wages: Tip Credits, Overtime, and Tax Rules

Federal tipped employee wage and tax rules give service workers a distinct pay floor, ownership over their gratuities, and, starting in 2025, a new income tax deduction of up to $25,000 a year on tip income. If you earn more than $30 a month in tips, the Fair Labor Standards Act treats you as a “tipped employee,” which changes how your minimum wage, overtime, and tip pool are calculated. Your tips belong to you, not your employer, and the One Big Beautiful Bill Act (P.L. 119-21) created a temporary federal deduction that runs through 2028.

Who Counts as a Tipped Employee

The FLSA defines a tipped employee as someone who customarily and regularly receives more than $30 a month in tips.¹ Servers, bartenders, valets, and bellhops are the standard examples. The phrase “customarily and regularly” means tips are a normal part of the work, not the occasional surprise.

If your tips fall below $30 in a given month, your employer has to treat you as a standard non-tipped worker for that period and pay the full minimum wage with no tip credit taken.²

Minimum Wage and the Tip Credit

An employer can pay a direct cash wage as low as $2.13 per hour if your tips bring your total hourly pay up to at least the federal minimum wage of $7.25.² The gap the employer fills with tips is called the tip credit, and it’s capped at $5.12 an hour. In any workweek where your tips fall short of that gap, the employer has to make up the difference in cash.³

Before an employer can take the tip credit at all, it has to notify you of the arrangement: the cash wage you’ll receive, the amount claimed as a credit, and the fact that the tips are yours. Skip that notice and the employer loses the right to the credit entirely, which usually produces significant back pay.²

Many states and cities set higher cash wages for tipped workers, and some prohibit the tip credit outright and require the full local minimum wage before tips are counted. Where state and federal rules conflict, the employer follows whichever is more protective of the worker.²

How Overtime Is Calculated

Overtime for tipped workers is one of the most miscalculated items on a restaurant payroll. When you work more than 40 hours in a workweek, overtime has to be figured from the full $7.25 minimum wage, not from the $2.13 cash rate.² The employer also cannot claim a bigger tip credit against overtime hours than against regular hours.

Your regular rate is the cash wage plus the tip credit taken, and overtime is one and a half times that regular rate. Tips you actually collect above the tip credit amount don’t count toward the regular rate.⁴ An employer that multiplies $2.13 by 1.5 and puts that on your check for overtime hours is underpaying you.

Who Owns the Tips

Tips belong to the employee. The FLSA prohibits employers from keeping any part of a worker’s tips for any purpose, whether or not they take a tip credit.¹ Employers cannot pull from your tips to cover broken dishes, walkout tabs, cash register shortages, or any other business cost.

Managers and supervisors cannot receive any share of employee tips, whether from a tip pool, a tip jar, or any other arrangement. A manager or supervisor for this purpose is someone whose primary duty is management, who regularly directs at least two full-time employees, and who has authority to hire or fire.⁵ The one narrow exception lets a manager keep a tip a customer hands directly to them for service the manager personally and solely provided.

Deductions for uniforms, tools, or equipment can’t reduce your pay below the federal minimum wage, and neither can charges for register shortages or customer walkouts. Because a tipped employee on the $2.13 cash rate has no cushion, almost any employer-benefit deduction from that base triggers a violation.⁶

Tip Pool Rules

Mandatory tip pools are legal, but who can be in the pool depends on whether the employer takes a tip credit. When the employer uses the credit, only workers who customarily and regularly receive tips can share, such as servers, bartenders, and hosts. When the employer pays the full minimum wage and skips the credit, the pool can include back-of-house staff like cooks and dishwashers.⁷

Two limits apply to every pool. Managers and supervisors can never take a share.⁵ And each employee has to end up with at least the minimum wage after the pool is applied. Pooled tips must be distributed in full by the regular payday for the workweek in which they were earned.²

Side Work and Dual Jobs

A server who spends part of a shift rolling silverware, cleaning tables, or brewing coffee is still doing work related to the tipped occupation, and the employer can keep taking the tip credit for those hours. If you actually hold two different jobs for the same employer, only the tipped-job hours qualify for the credit.⁸ The Department of Labor’s earlier “80/20/30” limit on side work was struck down in federal court in 2024 and formally withdrawn.⁹ Some states still enforce their own version, so local rules matter.

Service Charges Are Not Tips

A mandatory service charge added to a bill by the restaurant is not a tip, even though customers usually think of it that way. The IRS applies a four-part test: a genuine tip is voluntary, the customer picks the amount without negotiation, the payment isn’t set by employer policy, and the customer chooses the recipient.¹⁰ Miss any factor and the money is probably a service charge.

The label changes your pay and tax treatment. Service charges distributed to you are regular non-tip wages, subject to standard withholding, Social Security, and Medicare.¹¹ They don’t count as tips for the tip credit and don’t count for the No Tax on Tips deduction either. Don’t include auto-gratuities on your tip report to the employer.

Credit Card Processing Fee Deductions

When a customer tips on a credit card, the card company charges the business a transaction fee, and federal law lets the employer pass the proportional cost of that fee along to you. If the processing fee is 3%, a $20 tip can be reduced by $0.60.¹² The employer can use an average composite rate across transactions as long as the total collected doesn’t exceed what the card company actually charges.

Two limits apply. The deduction can’t push your pay below the federal minimum wage for that pay period, and the employer has to pay the credit card tip to you by the next regular payday even if it hasn’t yet been reimbursed by the card processor.¹² A handful of states bar these deductions altogether.

Reporting Tips for Taxes

Tips are taxable. If you earn $20 or more in cash tips in a calendar month, you have to report the total to your employer in writing by the 10th of the following month.¹³ Months below $20 don’t need to be reported to the employer, but the income still goes on your tax return.

Your employer withholds federal income tax, Social Security tax, and Medicare tax on reported tips. Social Security withholding applies until your combined wages and tips reach $184,500 for 2026; Medicare has no cap.¹⁴ When your non-tip wages can’t cover all the withholding, the IRS sets the order: withhold on regular wages first, then Social Security and Medicare on tips, then income tax on tips.

The No Tax on Tips Deduction

For tax years 2025 through 2028, qualifying tipped workers can deduct up to $25,000 in tip income from federal income tax each year. Congress enacted the provision in the One Big Beautiful Bill Act (P.L. 119-21).¹⁴

The deduction covers cash tips, which the IRS reads to include physical cash and charged tips received from customers or through tip-sharing. Mandatory service charges distributed by the employer don’t qualify. You have to work in an occupation that customarily and regularly received tips as of December 31, 2024. The benefit phases out above $150,000 in income for single filers and $300,000 for joint filers.¹⁵

You don’t have to wait for filing season to see it. Your employer should use an updated Form W-4 to adjust withholding during the year so your paychecks reflect the deduction now rather than as a refund later.¹⁴ This is an income tax deduction only. Social Security and Medicare taxes still apply to your tips.

What You Can Recover If the Rules Are Broken

The Department of Labor can impose civil money penalties of up to $2,515 per violation for repeated or willful minimum wage or overtime failures, and the amount adjusts each year for inflation.¹⁶

You can also sue directly. An employer that illegally keeps tips or takes a tip credit it wasn’t entitled to owes you the full amount of tips withheld plus the total tip credit taken, and the court adds an equal amount in liquidated damages on top of that.¹⁷ Attorney’s fees and court costs are recoverable too. These claims move faster when you have your own records, so keep a daily tip log independent of anything the employer prepares.

1
Office of the Law Revision Counsel. 29 U.S. Code 203 – Definitions
2
U.S. Department of Labor. Fact Sheet 15 – Tipped Employees Under the Fair Labor Standards Act
3
eCFR. 29 CFR 531.59 – The Tip Wage Credit
4
eCFR. 29 CFR 531.60 – Overtime Payments
5
U.S. Department of Labor. Fact Sheet 15B – Managers and Supervisors Under the Fair Labor Standards Act and Tips
6
U.S. Department of Labor. Fact Sheet 16 – Deductions From Wages for Uniforms and Other Facilities Under the FLSA
7
eCFR. 29 CFR 531.54 – Tip Pooling
8
eCFR. 29 CFR 531.56 – More Than $30 a Month in Tips
9
Federal Register. Tip Regulations Under the Fair Labor Standards Act – Restoration of Regulatory Language
10
Internal Revenue Service. Tips Versus Service Charges – How to Report
11
Internal Revenue Service. Tip Recordkeeping and Reporting
12
U.S. Department of Labor. Wage and Hour Division Opinion Letter FLSA2006-1
13
Internal Revenue Service. Topic No. 761 – Tips Withholding and Reporting
14
Internal Revenue Service. Publication 15 (2026), Circular E, Employer’s Tax Guide
15
U.S. Department of the Treasury. Treasury and IRS Issue Proposed Regulations Around No Tax on Tips
16
U.S. Department of Labor. Civil Money Penalty Inflation Adjustments
17
Office of the Law Revision Counsel. 29 U.S. Code 216 – Penalties