Article written by:
Dustin Minton, CPA, MBA
Director, Restaurant Services
In collaboration with Evan Cochran, Isaac Wiles
There has been much discussion and questions concerning how businesses that received a Paycheck Protection Program (“PPP”) loan should compensate tipped employees. The Fair Labor Standards Act (“FLSA”) and state law establish the minimum wage standards under which employees are to be paid. The FLSA states that a tipped employee is an employee that “customarily and regularly receives more than $30 a month in tips.” In most states, the “minimum wage” for tipped employees consists of a “minimum cash wage” and a “maximum tip credit.” Under applicable state law, an employer must pay a tipped employee the minimum cash wage, regardless of any customer tips received. An employer may then take a credit against the remaining amount necessary to pay the state minimum wage based on customer tips received (i.e., the maximum tip credit). For example, in Ohio, an employer is required to pay a tipped employee a $4.35 minimum cash wage and then is eligible to take a tip credit worth $4.35 based on the customer tips received by the tipped employee to ensure that the tipped employee receives at least the $8.70 Ohio minimum wage. If customer tips are not sufficient to pay a tipped employee the state minimum wage, then the employer must pay the difference. Thus, an employer is not required to pay any additional compensation so long as the tipped employee receives the state minimum wage based on the minimum cash wage and earned tips.
The impact on certain businesses due to COVID-19, along with the advent of PPP, adds a complicated dynamic for employers with respect to tipped employee compensation. The following is a recap on PPP and loan forgiveness as it relates to tipped employees:
- A business (i.e., the employer) applies for, and receives, a PPP loan, not the employees;
- The proceeds from a PPP loan may be used, at the discretion of the employer, on payroll costs and nonpayroll costs, including business rent and lease expense, mortgage interest, and utilities during the 8 or 24-week* PPP loan period;
- A business is eligible for PPP loan forgiveness based on PPP loan amounts spent towards payroll costs* and nonpayroll costs, subject to potential full-time employee reduction*, wage reduction penalties and a cap on nonpayroll expenses limiting those to no more than 40%* of the amount to be forgiven;
- Among other things, payroll costs for forgiveness purposes include “gross tips” incurred or paid, as well as “additional wages paid” to tipped employees as provided by the PPP; and
- A business is (i) not required to retain a tipped employee or (ii) pay a tipped employee wages in excess of the state minimum wage solely because the business received a PPP loan. However, such decisions may impact the amount of PPP loan forgiveness for a business.
As businesses reopen and rehire their employees, it is understandable that confusion exists among employers and tipped employees. Many businesses utilizing tipped employees during the early weeks of the PPP loan period* are still not fully operational, meaning employers must consider how best to compensate these employees for their lost tips. Businesses have implemented varying practices with respect to tipped employee compensation and although there is no “perfect practice,” employers must be mindful of both their PPP loan forgiveness objectives and the applicable employment laws. Below is an analysis of several practices that have been brought to our attention:
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Scenario |
Pros |
Cons |
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The employer sets a guaranteed hourly wage for tipped employees based on the estimated rate earned by the employee prior to COVID-19 and is paid by the minimum cash wage and customer tips. Employees retain tips in excess of the guaranteed wage or employers make additional cash wage contributions to arrive at the guaranteed wage. |
Payroll costs incurred should ensure the business meets the 60%* PPP loan forgiveness threshold, meaning the hourly wage reduction penalty is avoided. Better retention of tipped employees is expected. |
In certain instances, an employee may be more attracted to competitors offering compensation arrangements similar to Scenario 2, below. |
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The employer pays a set hourly wage to tipped employees based on (i) a pre-determined rate or (ii) the estimated rate earned by the employee prior to COVID-19 and employees retain the customer tips earned. The estimated rate considers the minimum cash wage and earned tips. |
Payroll costs are increased, allowing more of the PPP loan amount to be eligible for forgiveness and increasing the eligibility for nonpayroll costs to be forgiven. The hourly wage reduction penalty is avoided. Better retention of tipped employees is expected. |
Depending on when the PPP loan is received, PPP loan amounts will be depleted faster due to higher cash-out by the employer. |
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The employer pays the state minimum cash wage to tipped employees plus the customer tips earned, the combination of which exceeds the state minimum wage requirements. |
Compliant with the minimum legal requirements of compensating tipped employees. |
Inability to rehire/hire employees due to lower tips resulting from capacity constraints and social distancing rules. The hourly wage reduction penalty may apply to PPP loan forgiveness if the safe harbor is not met. |
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The employer pays a set hourly wage to tipped employees based on (i) a pre-determined rate or (ii) the estimated rate earned by the employee prior to COVID-19 and the employer retains the customer tips earned. The estimated rate considers the minimum cash wage and earned tips. |
None noted. |
The employees are likely stilled considered tipped employees for FLSA purposes (even if there is a brief decrease in available tips), meaning the employer’s retention of customer tips likely violates the FLSA. |
The FLSA is clear that an employer “may not keep tips received by its employees for any purposes… regardless of whether the employer takes a tip credit.” This does not preclude an employer from implementing a “tip pooling” program or retaining a compulsory “service charge” (i.e., a set percentage added to a customer’s check), both of which are subject to additional rules. Such a service charge is recognized by the business as income, but any amount left in addition to the service charge should be treated as a tip for compensation purposes. The retention of certain amounts of credit card tips to offset credit card processing charges is also permitted.
There are many considerations when determining how best to structure the compensation of your tipped employees during the PPP loan period. Employers must carefully balance any decisions from a hiring, employee retention, payroll tax liability, and legal compliance standpoint. It is important that employers communicate any temporary changes to the business’s pay practices to employees, and for employees to understand that these temporary changes are just that – temporary – and will likely last no longer than the PPP loan period. Open and transparent communication is necessary to avoid misunderstandings and poor employee morale. Employers and employees should also be reminded that the normal rules regarding compensation and the declaration of tips for income tax purposes still apply during the PPP loan period.
As an employer, it is important to contact your accounting and legal professionals immediately if you believe that your current compensation practices for tipped employees do not align with the FLSA or applicable state law. It is important that any error is quickly remedied for both your employees and for purposes of the PPP loan forgiveness application. See GBQ’s previous article discussing eligible payroll costs for tipped employees with respect to PPP loan forgiveness. If you find that you have questions surrounding your current compensation practices for tipped employees, please contact GBQ’s Restaurant Services Director Dustin Minton, or Isaac Wiles Associate Evan Cochran.
*On June 3, 2020, the Congress passed a bill that would allow for: (i) up to 40% of a PPP loan amount to be spent on nonpayroll costs (a change from 25%) and (ii) an extension of the PPP loan period to the earlier of 24 weeks or December 31, 2020. With bipartisan support, it is expected that the President will sign the bill into law. See GBQ’s article summarizing the PPP Flexibility Act of 2020.
