8.4 Tipped Employees: Tip Credit, Tip Pooling, Overtime & Form 8027

Tipped Employees: Tip Credit, Tip Pooling, Overtime & Form 8027

Tipped employment is the single largest source of FLSA back-wage recoveries in the food service industry, and it is tested on the CPP examination in three places at once: as an FLSA compliance rule, as a paycheck calculation, and as a reporting obligation. The arithmetic is unforgiving because the tip credit interacts with the overtime formula in a way that trips up experienced practitioners.

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1. Who Is a Tipped Employee, and What Is the Tip Credit

Under FLSA Section 3(t), a tipped employee is one engaged in an occupation in which they customarily and regularly receive more than $30 a month in tips. Section 3(m)(2)(A) permits the employer to count a portion of the employee's tips toward the federal minimum wage obligation.

+-----------------------------------------------------------------------------+
|                    FEDERAL TIP CREDIT ARITHMETIC (FLSA 3(m))                |
|                                                                             |
|   Federal minimum wage ................................. $7.25 per hour     |
|   Minimum required CASH wage for tipped employees ...... $2.13 per hour     |
|   Maximum federal TIP CREDIT ........................... $5.12 per hour     |
|                                                                             |
|   $2.13 cash + $5.12 tip credit = $7.25                                     |
|                                                                             |
|   IF tips actually received are less than the credit claimed,               |
|   the employer MUST make up the difference in cash for that workweek.       |
+-----------------------------------------------------------------------------+

The Four Conditions for Claiming the Credit

1. Advance notice. Before claiming the credit, the employer must inform the employee of (a) the cash wage being paid, (b) the amount of tip credit claimed, (c) that the credit cannot exceed tips actually received, (d) that all tips are retained by the employee except for a valid tip pool, and (e) that the credit does not apply unless the employee has been so informed.
2. Tip retention. The employee must retain all tips except for a valid tip pooling arrangement.
3. The credit cannot exceed actual tips. This is tested workweek by workweek, not by pay period or month.
4. The credit is capped at $5.12 federally. Many states set a higher cash wage or eliminate the credit entirely -- Alaska, California, Minnesota, Montana, Nevada, Oregon, and Washington require the full state minimum wage in cash -- and the more protective standard governs.

[!IMPORTANT] Service charges are not tips. A mandatory 18% or 20% charge automatically added to a large party's bill is not a gratuity; it is the employer's revenue. When distributed to employees it is ordinary wages, must be included in the regular rate for overtime, cannot be counted toward the tip credit, and is not reportable as a tip.

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2. Tip Pooling After the 2018 Statutory Amendment

The Consolidated Appropriations Act of 2018 amended FLSA Section 3(m) to make one rule absolute: an employer, manager, or supervisor may never keep any portion of an employee's tips, for any purpose, regardless of whether a tip credit is taken. The prohibition applies to managers and supervisors who meet the duties test of the executive exemption.

Willful violations expose the employer to the tips unlawfully kept, an equal amount in liquidated damages, and civil money penalties.

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3. Dual Jobs After the 80/20 Vacatur

The DOL's 2021 final rule split a tipped employee's shift into tip-producing work, directly supporting work, and unrelated work, and denied the tip credit when directly supporting work exceeded 20% of the workweek or 30 continuous minutes. In Restaurant Law Center v. U.S. Department of Labor (5th Cir., August 23, 2024) the court held that the rule was contrary to the text of FLSA Section 3(t) and arbitrary and capricious, and vacated it nationwide. The DOL issued a technical amendment removing the language from 29 CFR Part 531, effective December 17, 2024.

What survives is the original dual jobs regulation. If an employee genuinely works two occupations for the same employer -- a server who also works a separate maintenance shift -- the tip credit may be claimed only for the hours in the tipped occupation. There is no federal percentage test and no 30-minute clock. Several states, notably New York, retain their own 80/20-style rules, so a national employer cannot standardize on the federal position.

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4. Overtime for Tipped Employees

The single most common tipped-pay error is computing overtime on the $2.13 cash wage. The regular rate for a tipped employee is at least the full applicable minimum wage; the tip credit is subtracted after the overtime rate is computed.

Worked Example

A server works 46 hours in a workweek at the federal minimum wage, with a $5.12 tip credit claimed and $340.00 in tips received.

1. Straight-time cash: 46 hours × $2.13 = $97.98
2. Overtime rate before credit: $7.25 × 1.5 = $10.875
3. Overtime cash wage after credit: $10.875 − $5.12 = $5.755, rounded up to $5.76
4. Overtime premium cash due: 6 hours × ($5.755 − $2.13) = 6 × $3.625 = $21.75
5. Total cash wages: $97.98 + $21.75 = $119.73
6. Tip credit test: credit claimed = 46 × $5.12 = $235.52. Tips received of $340.00 exceed the credit claimed, so no make-up pay is owed.

Had the employer computed overtime as $2.13 × 1.5 = $3.195, the shortfall would be $3.36 per overtime hour -- doubled by FLSA liquidated damages and multiplied across a two-year (or three-year, if willful) look-back period.

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5. Tip Reporting: Forms 4070, 8027 and the 2026 W-2

Employee Reporting

An employee who receives $20 or more in tips in a calendar month must report the total to the employer by the 10th day of the following month, historically on Form 4070 with the Form 4070A daily record. Tips reported to the employer are wages subject to FITW, Social Security, and Medicare. If the employee's regular wages are insufficient to cover the tax on reported tips, the employer withholds to the extent of available wages and reports the uncollected Social Security and Medicare on Form W-2 Box 12, codes A and B.

Form 8027 and Allocated Tips

A large food or beverage establishment -- one where food or beverage is provided for consumption on the premises, tipping is customary, and more than 10 employees worked more than 80 hours on a typical business day -- must file Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips.

• If total tips reported by employees for the year are less than 8% of gross receipts, the employer must allocate the shortfall among directly tipped employees and report it in Form W-2 Box 8, Allocated tips.
• The establishment may petition the IRS for a lower rate, but not below 2%.
• Allocated tips are not subject to withholding and are not included in Boxes 1, 3, 5, or 7; the employee reconciles them on the individual return.

The IRC Section 45B Credit

An employer in the food and beverage industry may claim a general business credit equal to the employer's share of FICA tax paid on tips above the amount needed to bring the employee to $5.15 per hour (a figure frozen in the statute at the 1996 minimum wage, not indexed). The credit is claimed on Form 8846, and no deduction is allowed for the same FICA taxes.

New for 2026: Box 12 Code TP and Box 14b

The One Big Beautiful Bill Act created a federal income tax deduction of up to $25,000 for qualified tips for tax years 2025 through 2028, along with a companion deduction of up to $12,500 ($25,000 for joint filers) for the FLSA overtime premium. The IRS granted transition relief for 2025, but beginning with tax year 2026 employers must report:

Qualified tips must be voluntary and not subject to negotiation, which excludes mandatory service charges, and the recipient must work in an occupation that customarily and regularly received tips as of December 31, 2024. The amounts in codes TP and TT are already included in Box 1; the codes simply identify the deductible portion for the employee's Form 1040. Payroll systems must therefore accumulate qualified tips, non-qualified tips, qualified FLSA overtime premium, and non-qualified overtime as four distinct buckets throughout the year.