How do I handle payroll for tipped employees?
Tipped employees require different payroll handling than regular hourly workers. The main complexity is the tip credit, which allows employers to pay a lower base wage as long as tips bring the employee’s total hourly earnings up to at least minimum wage.
Federal law allows employers to pay tipped employees $2.13 per hour as a base wage if tips make up the difference to reach minimum wage. Michigan has its own tipped minimum wage that’s typically higher than federal requirements. You need to follow Michigan rules, and if an employee’s tips plus base wage don’t equal at least the full minimum wage for any pay period, you’re required to make up the difference out of pocket.
Track all tips, not just the ones from credit cards. Credit card tips are straightforward because they show up in your point of sale system and flow through payroll automatically. Cash tips are trickier. Employees are required to report cash tips to you if they exceed $20 in a calendar month, and you’re responsible for withholding taxes on those reported amounts. Many businesses use daily or weekly tip reporting forms that employees fill out each shift.
Tip pooling is allowed under certain conditions. You can require employees to share tips with other tipped workers like bussers, hosts, and bartenders. You cannot require them to share tips with managers, supervisors, or back-of-house staff who don’t customarily receive tips. Getting this wrong creates liability for back wages and potential Department of Labor issues.
Your payroll system needs to handle tipped wages correctly from the start. This means tracking different pay rates for tipped versus non-tipped hours, calculating tip credits accurately, verifying minimum wage is met each pay period, and properly reporting tips on W-2s. Most payroll processing software can handle these calculations, but the configuration has to be set up properly.
The most common mistakes are failing to track cash tips, miscalculating the tip credit when employees split time between tipped and non-tipped duties, and improperly including managers in tip pools. These mistakes result in back wages owed plus penalties that add up quickly.
This is especially relevant for beauty and personal care businesses like salons and spas where tips are standard. Having a professional review your payroll setup ensures compliance from day one and prevents costly corrections later.
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