According to the U.S. Department of Labor, a tipped employee is anyone who customarily and regularly earns more than $30 a month in tips or gratuities.
This includes the workers we all think of when we hear the word “tips”— waitstaff, bartenders, hair stylists, delivery drivers, bellhops, barbacks, bussers, and movers. But over the years, this group has also expanded to include entirely new job titles. Our own recent payroll data showed that the share of bakeries paying tips jumped from about 36% to nearly 50% between 2019 and 2024, coffee shops accepting tips grew from 56% to 72%, and the share of retail stores requesting tips nearly doubled.
If you run a small business, there's a good chance you have tipped employees—even if you don't think of yours as a "tipping" business.
Knowing who counts as a tipped employee matters, because our federal law sees them as distinct from non-tipped employees. Getting the distinction wrong is one of the most common (and expensive) payroll mistakes small businesses make. So let’s get clear on what a tipped employee is, and how you should pay them.
Why you should know who your tipped employees are
Under the federal Fair Labor Standards Act (FLSA), you're allowed to pay tipped employees less than the standard minimum wage per hour, as long as their tips make up the difference. The gap between the minimum wage for tipped employees and what you actually pay them in cash wages is called a tip credit, and claiming it can meaningfully lower your labor costs.
Our payroll data shows that tips significantly impact take-home pay: bar employees earned an average of $7.57/hour in base wages, but tips brought their total pay to $20.90/hour. Personal services workers averaged $18.38/hour in base wages plus another $4.23/hour in tips. With differences like that, it’s important to get the rules around who qualifies—and how much credit you can claim—right.
How the federal tip credit works
Since 2009, the math on calculating tip credit has remained the same. The federal minimum wage is $7.25/hour, and you can pay tipped workers a direct cash wage as low as $2.13/hour—a $5.12/hour tip credit—as long as tips cover the rest.
To legally claim a tip credit, you need to:
Tell the employee about the tip credit before you use it.
Let tipped workers keep all their tips, except for a valid tip pool.
Make sure tips plus cash wages equal at least the full minimum wage every pay period. If your workers’ total wages fall short, you owe the difference.
It’s also important to check the rules for your own state laws, which often set the minimum hourly wage much higher than the federal floor of $2.13.
Differences in state rules
Right now, seven states (Alaska, California, Minnesota, Montana, Nevada, Oregon, and Washington) don't allow a tip credit at all. In these states, employers pay tipped employees the full state minimum wage before tips.
In addition, some cities are actively scaling back or winding the tip credit down (like Flagstaff, Arizona, which fully eliminated it in 2026). Check your local rules before you run payroll—the DOL's state-by-state tipped minimum wage table is the fastest way to confirm the current rate.
The "dual jobs" rule: when a tipped employee does non-tipped work
Plenty of tipped employees also do work that doesn't generate tips, like a waiter who rolls silverware or a bartender who restocks the bar. The question is how much of that non-tipped work you can pay at the tip-credit rate.
The Department of Labor reverted to its long-standing "dual jobs" rule in December 2024, which looks at whether the employee has a genuinely separate non-tipped job (like server vs. cook) rather than tracking a strict percentage or time limit on side work. That reversed the Biden-era "80/20/30" rule, which had capped non-tipped side work at 20% of a shift or 30 continuous minutes.
The rules around this have changed a fair amount in the last few years, and there are still some regional nuances in how it's enforced. If you have tipped employees who also do non-tipped tasks, confirm which standard currently applies where you operate.
Tip pooling: Who’s entitled to tips?
If you pool and redistribute tips among employees, two rules matter:
Managers and supervisors can never take a share of a tip pool. They can only keep tips a customer gave them directly for service they personally provided.
Back-of-house staff (cooks, dishwashers) can only be included in a tip pool if you do not claim a tip credit, meaning you're already paying everyone the full minimum wage.
Misclassifying a manager as pool-eligible, or pooling with kitchen staff while still claiming the credit, is one of the most common triggers for a DOL wage-and-hour investigation.
The "No Tax on Tips" deduction
The One Big Beautiful Bill Act introduced a federal income tax deduction of up to $25,000 a year on qualified tips, available for tax years 2025 through 2028. It phases out for individuals earning over $150,000 and couples earning over $300,000. This is valid for a list of more than 70 qualifying occupations, and starting with tips earned in 2026, only tips separately reported on a W-2, 1099, or Form 4137 will qualify for the deduction.
A couple of things this deduction does not change: tips are still subject to Social Security and Medicare taxes, and employees may still owe state income tax on tips depending on where they live.
Take-home pay on tips has a direct, measurable effect on whether tipped employees stay. When Montana started taxing tips for the first time in 2024, our own data showed tipped employee attrition jumped 81%, adding roughly $8,000 a year in turnover costs for the average small business.
A federal deduction that increases take-home pay works in the opposite direction, which is good news for retention, at no added cost to you.
FAQs
How much can you legally pay a tipped employee under federal law?
Federal law allows employers to pay tipped employees a direct cash wage as low as $2.13/hour, as long as tips bring their total pay up to at least the federal minimum wage of $7.25/hour. That $5.12/hour gap is the tip credit. Many states set higher minimums, so check your state's rules before setting pay.
What happens if a tipped employee's tips don't add up to minimum wage?
The employer has to make up the difference. If an employee's cash wage plus tips falls short of the applicable minimum wage in any pay period, federal law requires the employer to pay the shortfall directly. Tipped employees are always guaranteed at least full minimum wage.
Is a mandatory service charge the same thing as a tip?
No. The IRS treats mandatory service charges, like an automatic 20% gratuity for large parties, as regular wages, not tips, since the customer has no choice in paying. Service charges don't count toward your tip credit and must run through payroll with full tax withholding, unlike true tips.
Can managers or supervisors keep tips from a tip pool?
No. Managers and supervisors can never take a share of an employee tip pool, even if they occasionally do tipped work themselves. The only tips they can legally keep are ones a customer gave them directly for service they personally and solely provided.
Does the "No Tax on Tips" federal deduction also apply to state income taxes?
Not automatically. The deduction only cuts federal income tax, and each state decides separately whether to adopt it. As of mid-2026, roughly 19 states conform, but several (including California, New York, and Illinois) have not, so tipped workers there still owe state tax on tips.
Quick note: This is not to be taken as tax advice. Since tax rules change over time and can vary by location and industry, consult a CPA or tax advisor for specific guidance. Find an accountant
