Tips are essential for providing a living wage in some service industry positions. Still, the unpredictable nature of tipping can make things tricky for employers when managing payroll and taxes. Tip pooling is a way for employers to limit payroll complexity, ensure reporting accuracy, and maintain a positive consumer experience.
What you’ll learn
What you’ll learn
Key takeaways about tip pooling
- Tip pooling is a method of distributing tips amongst a group of workers
- The process can increase tip fairness, but it may negatively affect some employees
- There are four popular distribution methods: equal, hourly, role-based, and point-based
That said, without a plan in place, there’s the risk of unfair tip distribution which may negatively affect competition and customer service. Let’s explore the concept, learn about tip pooling laws, and get up to speed on your potential obligations as an employer in the service industry.
How does tip pooling work?
Put simply, tip pooling is the process of collecting all tips earned by customer-facing employees — servers, bartenders, etc. — and redistributing those tips among a wider group, including workers who don’t directly interact with customers, such as kitchen staff and bussers. It’s important to keep in mind the differences between tip pooling vs. tip sharing. Pooling is often mandatory, while sharing is voluntary between employees. Sharing is more flexible, but pooling must follow strict laws.
Some argue that tip pooling increases fairness by ensuring all those who contribute to the customer experience share in the reward. Proponents also suggest that pooling encourages teamwork and a shared sense of responsibility while reducing inequality. Opponents of these policies say pooling is unfair to employees who directly interact with customers because they are the ones directly generating the tips. They argue pooling takes money from customer-facing employees and may reduce their motivation to provide exceptional service.
Regardless of your stance, it’s important to understand that pooling laws exist. If your establishment decides to implement a mandatory tip pooling policy, it must comply with all existing laws and regulations.
Now that we have that primer on tip pooling, let’s discuss the ways that wages can get from point a to point b, or from customer facing employees, to the pool, to everyone.
Distribution methods among employees
Each establishment and its staff must decide how to split tips between employees when pooling. There are four popular tip pooling methods.
1. Equal distribution
Equal distribution is the simplest method. Employees combine credit and cash tips and divide them equally. The technique is easy to implement and can promote a strong sense of teamwork, but it might not be fair to all employees.
2. Hourly distribution
Hourly distribution is more challenging but improves fairness. The distribution of the tip pool accounts for the time each employee contributes. However, this still doesn’t always reflect the varying levels of responsibility among employees and positions.
3. Role-based distribution
Role-based distribution attempts to counteract the shortcomings of the previous two methods. In this method, employees with more responsibility receive a more significant portion of the tip pool. The main downside is the difficulty in figuring out fair percentages.
4. Point-based distribution
Finally, points-based distribution awards a specific number of points to each employee based on position, shift length, and performance. Each employee receives tips in accordance with their accumulated points. This is a flexible method, but it’s complex and requires careful monitoring.
Are you thinking it’s time to put tip pooling into practice at your place of business, but you’re unsure of how to get started? To provide some actionable guidance, we turned to David Kindness, a certified public accountant and a frequent contributor to OnPay’s small business content.
Read up on rules
“Tip pooling policies can be implemented right away, as long as they adhere with all tip pooling regulations. These regulations can vary by state or locality, so it’s important to understand the regulations that apply to your specific location and place of business. A CPA, payroll provider, or attorney can help solidify these guidelines for you.”
— David Kindness, CPA and OnPay subject matter expert
Once you understand the laws and have decided which tip pooling method you’d like to implement, the next challenge is setting it up and tracking it. “This is where a payroll software, like OnPay, can be immensely helpful,” explains David. “Most online tools can help you set up tip pooling rules and can even track hours, points, and more, making it easy to allocate tips appropriately.”
Tell your team
“An internal payroll team or external payroll provider can also manage this process for you. Simply let them know that you’re implementing a tip pooling policy and inform them of which method you’ll be using, as well as the rules you’d like to follow when allocating tips.”
— David Kindness, CPA and OnPay contributor
Next, let’s take a look at how some employers go about putting this into practice.
Best practices for creating a tip pooling policy
A well-structured and regulated tip pooling arrangement requires forethought. You should follow best practices when implementing the policy:
- Defining eligibility (Will the policy include non-tipped employees?)
- Establishing fair and transparent distribution practices
- Documenting the policy
- Maintaining accurate records for payroll processing
You’ll also need to read and understand all relevant laws. The Fair Labor Standards Act (FLSA) has employee participation and tip distribution rules. Many states also have laws that may be even more restrictive than the FLSA.
Legal considerations and compliance
Employers must maintain and communicate a clear tip-pooling policy if they choose to have one. They must also keep accurate records of tips and distributions that affect an employee’s gross pay vs. net pay.
Gross pay refers to money earned before taxes and deductions. Net pay is money earned less the applicable taxes and deductions. Tip pooling will have an effect on everyone’s gross pay, whether it’s increasing or decreasing.
As far as legal obligations and compliance issues, employers have a couple of legal considerations when it comes to tips. Let’s explore these legal considerations below.
Minimum wage obligations
Employers are allowed to pay tipped employees less than the federal minimum wage if they take a tip credit. With a tip credit, employers can pay tipped employees a lower direct wage ($2.13 per hour) as long as the employee’s tips and direct wages in total meet the federal minimum wage requirement.
If the employer uses the tip credit option, then they can use tip pooling, but only in a limited fashion. The pool can only include employees who regularly receive tips, such as servers and bartenders.
Restrictions of management’s involvement
While management can create a tip pooling policy, it cannot keep any portion of an employee’s tips — that goes for supervisors and employers as well. Even if an employer doesn’t take a tip credit, it has no legal right to keep any tips. Violating this rule can lead to significant fines and lawsuits.
Now that we have some guidance on setting up a tip pooling structure, you may be wondering about how this can have an impact on your bottom line. Once more we caught up with David Kindness for his two cents on what to keep in mind when setting this up.
“One benefit of a tip pooling policy is that it can cost relatively little to set up and maintain (just a little time and some math). That makes it a potentially powerful and inexpensive tool for improving employee satisfaction – and potentially your bottom line as well.
For example, employee satisfaction may be lower for workers who do not receive tips, like bussers and cooks, than for those who do receive tips, like hosts, hostesses, and servers. Utilizing a tip pooling policy can allow you to keep your client-facing staff happy and well-tipped while also improving the satisfaction of your non-client-facing workers.”
— David Kindness, CPA and OnPay subject matter expert
Improving employee satisfaction and keeping your workplace fair can help reduce turnover, decrease your hiring and training costs, and improve your bottom line. Similarly, tip pooling can reduce employment costs by reducing employees’ base pay and offering them tips, which can be significant, instead.
“As always, it’s important to make sure that you comply with all FLSA and state laws, and keep accurate records right from the start,” David says.
Financial implications for restaurant owners
Tip pooling can come with administrative costs, such as tracking tips, calculating distributions, and ensuring compliance with laws. Thankfully, tools such as a tip tax calculator and payroll software can help with these common issues.
While there are costs, pooling can also offer financial benefits thanks to:
- Reduced labor costs
- Improved employee morale and retention
- Increased efficiency and teamwork
Pooling can be financially beneficial when implemented thoughtfully. Still, it’s important to consider the pros and cons for your business before you start figuring out how to calculate tip pooling.
Calculating pooled tips
Calculating pooled tips depends on the distribution method. You can simplify the calculations by using OnPay’s software to manage employee tips and compliance issues.
Fair distribution techniques
Whether you use equal, hourly, role-based, or point-based distribution, you must ensure fairness. What’s fair depends on your business structure and culture. A role- or point-based model is often the fairest system, but also the most complex to manage.
Motivating employees through tips
Tips are often a strong motivator for employees in the service industry because they represent recognition and appreciation while offering an extrinsic reward. Still, how effectively tips motivate workers varies by employee. It’s best to combine them with fair compensation policies, employee recognition, and a positive work environment.
Takeaway: Tip pooling has positives for employers and employees
Tip pooling can help create a more equitable and collaborative workplace. By having a thoughtful plan when putting it in place, it can help foster teamwork between front- and back-of-house staff and make sure everyone on your team receives fair compensation no matter their role. The key is choosing a distribution method that fits your establishment’s needs while maintaining clear communication and regulatory compliance. Best of luck as you set up a tip pooling policy, and remember, many online payroll providers can help to simplify it all.
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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.