How the Tip Credit Actually Works (and What Your Employer Owes You)

The Basic Math

Under the Fair Labor Standards Act, an employer can pay a tipped employee a cash wage of as little as $2.13 per hour, then count up to $5.12 per hour of the employee's tips toward the employer's minimum wage obligation. $2.13 plus $5.12 equals $7.25, the federal minimum wage. That $5.12 is the tip credit: the maximum slice of your tips the employer is allowed to treat as part of your wage.

Three things about this math trip people up. First, $2.13 is a federal floor, not a national rule. Many states require a higher cash wage, and when state and federal law differ, the standard most favorable to the employee wins. Second, the credit can never exceed the tips you actually received. If you earned $3.00 an hour in tips on a slow Tuesday lunch, the employer's credit is capped at $3.00, not $5.12. Third, and most important, the whole arrangement collapses unless the employer meets five specific requirements first.

The Five Requirements (Especially Number Five)

Before an employer can claim a penny of tip credit, the Department of Labor's Fact Sheet #15 requires them to inform each tipped employee of five things:

1. The cash wage the employer is paying, which must be at least $2.13 per hour.

2. The additional amount the employer is claiming as a tip credit, which cannot exceed $5.12.

3. That the claimed credit cannot exceed the tips the employee actually received.

4. That all tips belong to the employee, except for a valid tip-pooling arrangement limited to employees who customarily and regularly receive tips.

5. That the tip credit does not apply at all unless the employee has been informed of these provisions.

The notice can be oral or written, but it has to happen. Here is the part almost nobody knows: an employer who fails to give this notice cannot use the tip credit at all, and must pay the tipped employee the full minimum wage for every hour worked while letting the employee keep all tips. I have seen wage claims turn entirely on this point. The employer did everything else right, paid $2.13, counted tips, but never told anyone the rules, and that single omission converted years of $2.13 hours into $7.25 hours owed as back pay.

Makeup Pay: The Employer's Safety Net Is Not Yours

The tip credit only works if your total earnings actually reach the minimum wage. Cash wage plus tips must equal at least $7.25 per hour for every hour worked (or your state's higher minimum). If tips fall short, the employer must make up the difference. This is not optional, and it is not averaged across a good week to cover a bad one in the way some managers imply. It is a hard federal requirement.

In practice, makeup pay is the most commonly violated part of the tip credit system. It requires the employer to track tips accurately every pay period and true-up shortfalls, and plenty of small operators simply do not. If you work tipped shifts, keep your own log of hours and tips. It takes thirty seconds after a shift and it is the only evidence that matters if a shortfall ever becomes a dispute.

Your Tips Are Your Property. Full Stop.

This one deserves its own section because it surprises people: a tip is the sole property of the tipped employee, whether or not the employer takes a tip credit. The FLSA prohibits any arrangement where part of your tips becomes the employer's property. Even if your employer pays you the full minimum wage in cash and takes no credit at all, they still cannot require you to hand over your tips to the house.

Tip pooling is the one exception, and it has its own rules. When the employer takes a tip credit, a mandatory pool can only include employees who customarily and regularly receive tips: servers, bartenders, bussers, hosts who serve. Cooks, dishwashers, and janitors cannot be in that pool. Managers, supervisors, and owners can never take from the pool, period. When the employer pays everyone the full minimum wage and takes no tip credit, a broader "nontraditional" pool is allowed, but managers and owners are still excluded. If your manager has been dipping into the tip pool, that is not a gray area. It is a violation.

Seven States Skip All of This

Everything above describes federal law, which is the floor. Seven states prohibit the tip credit entirely: Alaska, California, Minnesota, Montana, Nevada, Oregon, and Washington. In those states, employers must pay tipped workers the full state minimum wage as a cash wage, and tips are purely extra on top. A server in Washington earns at least $17.13 an hour from the employer before a single tip lands on the table. I break down all seven, with 2026 rates and what changes for payroll, in the 7 states with no tip credit in 2026.

And if you want the raw numbers for every state, the tipped cash wage, the maximum tip credit, and which states ban it, download the free 2026 tipped minimum wage dataset and check your state in seconds.