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The trouble with tips

Business- crushing lawsuits and tedious rules have some operators debating whether it’s time to topple the practice of tipping completely.

A few years ago, Bruce Thomas pulled the tip jars off his counters. It was better than getting sued.

As director of operations for 10 Dunkin’ Donuts around Massachusetts, Thomas was watching other stores get hit with lawsuits over which workers were allowed to share in the contents of the jars. He didn’t want to be the next in line. But it was a bitter choice. “It’s not fair to the kids working the front line,” he says. “It’s cutting their pay by 20 to 25 percent. A lot of these people depend on it. It could be their gas money, their cigarette money, their grocery money.”

Few customs have been as ingrained in America’s restaurants as tipping. For decades, it seemed like the ultimate win-win-win. Diners relished the power to reward service, while servers liked enhancing their incomes. And restaurant operators depended on the tip credit to hold down labor costs. By subtracting up to $5.12 an hour from the minimum wage they’d otherwise have to pay, they could cut server expenses by as much as two-thirds; customers would make up the difference.

Today, though, legislative campaigns around the country are seeking to shrink the tip credit, while the credit itself has turned into a legal minefield. One wrong step, and it can explode into a class-action lawsuit or an investigation by the U.S. Department of Labor. “If you do it right, it’s a very attractive prospect,” says Atlanta employment lawyer John Mays. “The downside is, if you do it wrong, the consequences can be tremendously bad.”

Unlike quarters tossed in a tip jar on the counter, the amounts in play are not chump change:

  • Last August, Starbucks paid out $23.5 million after losing a Massachusetts class-action lawsuit over sharing tips with supervisors.
  • In 2012, Applebee’s International paid $9.1 million to 5,680 claimants. The money settled a suit over time that servers spent on non-tipped work.
  • In February, a DOL probe won $6.8 million from Philadelphia sports-bar chain Chickie’s & Pete’s over money the owner took from tip pools at its 12 units.

“Restaurants have opened a Pandora’s box for plaintiff lawyers,” says Carolyn Richmond, a New York City hospitality attorney who’s defended a who’s who of Manhattan eateries. Tipping laws have been on the books for decades, she says. But many restaurants grew lax about observing them, because they were both complicated and rarely enforced—until recently.

“Lawyers started realizing that class-action wage-and-hour lawsuits are more lucrative and less labor intensive than traditional discrimination suits,” says Richmond. “There’s a whole panoply of other laws that nobody had paid attention to, like tipping and service charges, minutiae that didn’t affect other industries.”

Minute as a tipping violation might sound, the penalties can pile up fast. Mays figures that if a restaurant paid a server $114 for a 45-hour week, back wages and penalties can add another $347. That figure includes the amount the restaurant took as a tip credit and federal laws that double the damages. A class-action suit brought against a large chain can multiply that number by thousands of servers.

The law of gratuity

While legal details may boggle the mind—a guide from the National Restaurant Association runs 16 pages—most tipping lawsuits hinge on two basic questions: who gets to share in the tips and what should servers be paid when they’re not serving?

Who gets to share in the tips? Thirteen years ago, Boston attorney Shannon Liss-Riordan got a call from a waiter, who protested that his manager had his hand in the tip jar. Under state law, she argues, that’s illegal—and she’s won a string of court cases against restaurants, including Starbucks. In the Starbucks suit, judges ruled that shift supervisors were managers and had to quit sharing tips.

Starbucks later promoted Massachusetts shift supervisors into a new position called shift manager and raised their pay, which Liss-Riordan says was one of her goals. “We wanted Starbucks CEO Howard Schultz paying rather than the baristas,” Liss-Riordan says.

At Starbucks in the other 49 states, though, nothing has changed, and courts in California and New York have sided with the coffee giant. “We believe shift supervisors are entitled to share in those tips,” says spokesperson Maggie Jantzen. “They spend the majority of time providing the same duties as baristas and dealing with customers.”

In Oregon, tip pools face a different question: Can the kitchen get a cut? Under state law, restaurants aren’t allowed tip credits, and servers make full minimum wage, plus tips. That creates huge income gaps and potential resentments between waitstaff and everyone else, says Christopher Handford, owner of the Davis Street Tavern in Portland, Ore. He narrows those gaps by sharing the wealth. Chefs and dishwashers, on average, get an extra $1.25 an hour from the tip pool. “The way we look at it, customers are tipping the entire staff: the dishwasher, the waiter, the bartender, the person who busses the tables, the hostess,” says Handford.

Under a 2011 rule from the DOL, his tip pool is illegal because it includes workers who don’t customarily receive tips. But federal courts in the Ninth Circuit (covering nine western states and Guam) have said the rule doesn’t apply to restaurants that don’t ake tip credits. Of seven states that outlaw tip credits, six happen to be in the Ninth Circuit.

Handford is suing the DOL for the right to keep his tip pool, and three state restaurant associations and the NRA have joined him. Says Scott DeFife, executive vice president of policy and governmental affairs for the NRA, “The [Labor] Department’s position is putting operators in a no-win, Catch-22 situation.”

What should servers be paid when they’re not serving? In 2006, employment lawyer Chip Gentry of Jefferson City, Mo., was eating at an Applebee’s. His server complained to him about the hours he spent cleaning, prepping food and stocking shelves. That work wasn’t earning him tips, but he still was getting paid only $2.13 an hour.

Under Department of Labor rules, such side work can only take up 20 percent of a waiter’s time. If the work takes longer, it’s supposed to be treated as a separate job and pay full minimum wage—a concept often called “dual jobs.”

“The rule is designed to prevent abusing your labor force, hiring people you can pay less than minimum wage to do minimum-wage work,” says Gentry.

When Gentry learned that the DOL had just investigated some Applebee’s stores over breaking the 20 percent rule, he launched a class action. Applebee’s challenged the rule all the way to the U.S. Supreme Court. After losing its appeals, the chain settled for the extra wages.

Applebee’s declined to comment for this story. But its headaches might not be over. An Illinois franchisee went bankrupt after losing a dual-jobs lawsuit, and two others are facing tip-related suits. Says Gentry, who’s seeking more disgruntled Applebee’s workers, “I fully anticipate additional cases to crop up.”

Waging war

Courtrooms aren’t the only places where tip credits are under attack. Thirty-one states have tipped minimum wages that exceed the federal. This year, at least five face bills or ballot initiatives to raise them further.

In Massachusetts, where operators are fighting a proposed increase of 71 percent, some say they’ll be forced to cut waitstaffs in half. Says Steve Clark, director of government affairs for the Massachusetts Restaurant Association, “You’ll absolutely see menu price increases, and you’ll see more limited availability of service.”

In the U.S. Senate, a bill supported by the Obama administration would boost the tipped minimum to 70 percent of the full minimum wage. It’s currently 29 percent, and backers note the amount has not changed in 23 years, while the full wage has risen 71 percent.

That argument ignores one point, says DeFife: “No one is making $2.13 an hour.” According to surveys conducted by the NRA, the average tipped employee takes home $16 to $22 an hour.

If servers do get a higher minimum wage, he warns, other workers will pay the price. “Arbitrarily doubling or tripling the cash wage for tipped employees comes at the expense of the ability to properly compensate folks in the back of the house.”

To tip or not to tip

Is tipping still worth the trouble? A number of restaurant owners have decided it’s not.

In Athens, Ohio, Casa Nueva ran a tip pool for most of its 28 years. A worker-owned co-op, everyone got their share—until 2012, when the DOL ruled the pool was illegal. Rather than give up pooling, the workers decided to give up tips.

They raised menu prices 16 percent and divvied up the extra revenue the way they had formerly done with tips. To remind customers not to tip, servers wore buttons with a red circle and slash over the word “tips.” Says Food Coordinator Manager Al Schmidt, “Some people do still leave money on the table, even though we try to dissuade them. We pick a different local charity every month and donate the money.”

At his former San Diego restaurant The Linkery, owner Jay Porter says revenue per server went up 50 percent after he stopped accepting tips. He replaced them with a fixed service charge, which he was free to allocate among all his staffers, under DOL rules.

“Everyone in the front of the house started working as a team, free from having to generate their own revenue,” he says. “This resulted both in better service, which led to more revenue, and in more efficient service, which led to lower labor percentages.”

But other businesses are taking the opposite tack: making it easier for customers to tip. In March, Starbucks added a digital tipping option to its mobile-payment app. After paying the bill, a customer can add a tip of 50 cents, $1 or $2. The app accounts for 11 percent of the chain’s transactions.

Tipping will survive, predicts Cornell University marketing professor Michael Lynn. Not because it rewards good service—his research finds service ratings explain less than 2 percent of variations in restaurant tips. It’s because the practice gives diners a sense of power, he says. “From the customers’ perspective, the strongest argument for tipping is that it gives them a measure of control and a guarantee of service quality they wouldn’t otherwise have,” says Lynn.

Likewise, many servers still would rather work for tips than for higher wages. “I totally prefer tipping,” says Paul Paz, a 35-year server who’s now at the Oswego Grill in Oswego, Ore. “It allows me to elevate my tableside skills and technique. It allows me to provide myself an income that’s way above minimum wage.” 

Tips on tipping: How not to get sued

Most restaurants don’t mean to flout complex tipping rules, says Washington, D.C., attorney Kara Maciel. “It’s just difficult to find themselves in full compliance.” She and other hospitality lawyers suggest these practices to avoid pushing the legal envelope:

Out of the pool. Under federal rules, all tips belong to servers who collect them. Management can’t deduct for business expenses or to share the gratuities with non-tipped workers. Says Carolyn Richmond of New York City, “If your primary job function is not providing tipped work, you shouldn’t be taking tips.”

Divide dual jobs. “There’s no reason to have somebody who’s primarily out there doing service staying after work to clean up,” says Atlanta employment attorney John Mays. If a server has to mop the floor or brew the coffee, have them clock out and back in to keep the hours separate.

Put it in writing. A poster is not enough. Recent rules from the U.S. Department of Labor require notifying workers in detail of your tip-credit policies. Plus, written policies may help protect you if DOL investigators come knocking.

Audit your tip practices.  Job duties are always changing, and so are tipping regulations. Maciel recommends an audit at least once a year. “Highlight the issue to make sure you put in compliant practices,” she says. “Get them in before someone files that lawsuit.”


Adios to auto grat?

When is a tip not a tip? When a customer has no say-so. So says an IRS ruling that took effect in January. Although it’s a clarification of existing rules,  it has taken many full-service restaurants by surprise.

Under fire: tacking on automatic gratuities for large parties. It remedies a complaint from many servers that guests in large groups tip less than average. But the taxman says
it’s not a gratuity if it’s automatic. A customer must be free to decide how much to tip or whether to tip at all. “If the restaurant removes any of the customer’s discretion, it becomes a service charge,” says Peter Kilgore, general counsel for the National Restaurant Association.

Service charges are perfectly legal, but must be reported as revenue by the restaurant. Whatever is passed on to workers is treated as wages, and the restaurant can’t take a tip credit for it.

Since the ruling, many restaurants have scrapped auto grats. Darden Restaurant now suggests tips of 15, 18 and 20 percent. Its guests and servers don’t mind, says spokesman Rich Jeffers. “Overall, our servers have seen no significant change in tip percentages for large parties.”

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