Hot Tips & Takes: How Restaurants Can (Legally) Structure Tip Pools, Service Charges, and More

With ever-changing legislation — and mounting litigation — service fees and tip policies have become a hot topic.

In this Hot Tips & Takes interview, Beth Schroeder, a partner at Raines Feldman LLP, addresses common misconceptions that can get restaurant operators, owners and execs into legal hot water.

Beth is a preeminent Labor & Employment counsel with more than 30 years of experience in representing employers in all aspects of employment and labor law. Read what she has to say about restaurant service charges, surcharges and tip pools below. (Keep in mind: while resources like this are a good place to start evaluating your policies, they aren’t intended as legal advice! If you have questions or concerns, seek legal counsel, ideally from an attorney or firm with hospitality expertise.)

How are restaurants dealing with minimum wage hikes, labor shortages, and other challenges that have been putting a financial strain on the industry?

If you don’t think you’ll be taking these costs on as a patron, think again. When labor goes up, no matter what industry you’re in, most likely that increase is coming back to the consumer.

Between Covid, minimum wage hikes, sick pay, the ACA…this industry has been through a lot. Restaurants felt like they were laid bare — so they have no choice but to ask their patrons to share in some of that increased burden. It’s not just increased menu prices, although that’s certainly happening. But we’re also seeing service charges, surcharges, and changes to tip policies.

Let’s start with service charges. How are service charges supposed to work, and how do restaurants get it wrong?

Terminology is a big issue. Service charges, surcharges, auto-gratuity — they’re often used interchangeably, but they’re all used differently, and they all have different legal stipulations and requirements.

Service charges are not gratuities. Instead, a service charge is a set percentage that is added to your check. It’s assessed by a restaurant, and it’s placed on the menu like any other menu item. Three things to keep in mind about a service charge:

  • It’s should not be negotiable.
  • There’s a sales tax placed on it.
  • If handled correctly, it is the property of the restaurant.

When you say it is the property of the restaurant, does that mean the service charge does not go to the employees?

Any revenue generated from a service charge is the property of the restaurant, so the restaurant can decide what to do with it They don’t have to pay any of it out to employees, but they can.

This is a key difference between a service charge and “auto-gratuity.” Auto-gratuity is really a misnomer, because the word “gratuity” itself implies that the money left by the patron is left at the will of the patron, and therefore, should be treated as a tip and the property of the employee. But the term “auto” suggests that the money is mandated, and thus, is more like a service charge. Restaurants have used this term for years to refer to a service charge, but as you can see, it is confusing nomenclature, to employees, guests and the courts. I highly suggest as an industry we get away from using this term.

Keep in mind: If restaurants choose to give some percentage of their service charges to employees, those funds must be brought in as wages, not gratuity. That money paid to employees will be treated paid as wages to the employees and will increase their regular rate, for purposes of issues like overtime, meal breaks and the like.

It’s incredibly important for restaurants to be transparent as to how they’re using the service charge. If it’s not going to employees, or if only a small percentage goes to employees, guests need to know that so they can add their own gratuity. It’s wise for restaurants to post those details on their website, menu, etc. Employees should also be made aware, to avoid any claims of uncertainty in litigation.

So, what’s the difference between a service charge and a surcharge?

Like a service charge, a surcharge is a set percentage that’s added to the guest check. Whereas a service charge can be up to 20% of your total bill, a surcharge is usually a smaller amount, say, up to 10%, so as usually not to supplant the tip, but seen as paid to the restaurant in addition to a tip.

These days, many restaurants like to defend the use of adding a surcharge onto their bill by qualifying the surcharge with words like “healthcare surcharge,” or “PPE surcharge.” The use of those qualifiers are fine, but then the restaurant will be limited to using the funds generated from the surcharge solely for that purpose, or risk lawsuits from local attorneys or even district attorneys for consumer fraud lawsuits. For example, starting in 2020, some restaurants instituted “Covid surcharges,” and that money went toward PPE and additional sanitation supplies. Balance the value of adding this language – I’ve suggested just sticking the term “surcharge” and giving yourself more flexibility.

We’re seeing both service charges and surcharge mostly in areas where the minimum wage is going up.

Is there a downside to leveraging service charges or surcharges?

No matter what, patrons will ultimately end up paying for rising costs of goods and services. As opposed to constantly playing with menu prices, service charges and surcharges can be easier to shift around as your business and the market change. And sometimes restaurants think that keeping menu prices stable makes them more competitive, even if it all comes out in the wash.

On the flip side, both service charges and surcharges can blindside patrons when they see an extra charge on their check. And while restaurants are required to communicate what surcharge funds are going toward, service charges aren’t required to have the same level of transparency. Both have led to lawsuits where employers have been accused of misleading employees or patrons or of misusing funds.

That’s why it’s so important to ensure that you’re being completely transparent with both employees and patrons. I.e., be clear about the purpose of the charge, and ensure that the funds are used in that exact manner.

Let’s talk tips. How are tips different than service charges and surcharges, in terms of how restaurants can use the funds?

Service charges and surcharges are predetermined charges mandated by the restaurant, and they belong to the employer. When paid to the employees, they also become wages and can be used to offset minimum wage. Tips, on the other hand, belong to employees — not employers, not management — period. They cannot be retained by the restaurant nor used to offset wages in any manner, although employers are responsible to see that employees accurately report their tips for tax purposes.

Why are we seeing more tip pools (and more lawsuits around tip pools) lately?

Tip pooling requires tip-eligible workers to pool all or a portion of their tips together at the end of a shift. The tips are then redistributed (often equally) among all tipped employees. Employers and management absolutely cannot participate in a tip pool, but restaurants CAN mandate a reasonable tip pool under federal and most state laws.

Many restaurants misunderstand the rules around tip pooling and shy away from it. But in most states, like California, employers are permitted to be actively involved in administering tip pools and tip sharing programs, so long as they follow the rules about who can participate in those tip pools and to what percentage.

Until recently, the rules about allowing back of the house or kitchen employees until a tip pool were murky. However, that rule was officially changed and approved by the Department of Labor in 2018. It’s now allowed in states where there isn’t a tip credit — so, primarily the West Coast. Restaurants are starting to dip their toes into it, and it has become much more popular during the pandemic.

Tip pooling can help to increase earnings of restaurant workers, especially those who might not be as customer-facing — but it can get employers into legal trouble. Million-dollar lawsuits have been filed due to illegal tip pools. Common issues include:

– Management or management employees taking part in the tip pool
– Employees being unclear about the rules of the tip pool (lack of transparency and communication)

Employees and managers wear a lot of hats. What if you’re not tip eligible, but you find yourself performing the duties of someone who is?

There are a few points to consider here…

  1. Direct tips: It’s important to note that no matter your title, if you’re tipped directly by a patron, you can keep that money. So for example, a manager can’t accept a tip out from a tip pool — but if a patron hands that manager $20, it’s hers to keep.
  2. Putting managers on the clock: Managers often get the short end of the stick. If they leave a tip-eligible role to become a manager, they are working harder for less pay because they’re not receiving tips. When my clients are concerned about their managers getting fairly compensated, I’ll tell them to consider taking managers off salary and putting them on the clock if most of their duties aren’t exempt anyway. So: let them pick up tables and get tips.
  3. “Quasi-managers”: Especially at fine dining restaurants, you’ll find a lot of different categories of workers: maître d, sommeliers, table captains, etc. Some of these people may have management duties, and there can be a lot of gray area as to whether these people can receive tip outs from other employees.

In regards to number 3, the guidance is that if the person is acting as an employer in relation to the employee, they aren’t tip-eligible. A few questions to help make that determination:

  • Can they hire and fire employees?
  • Do they control employee work schedules?
  • Do they determine the rate/method of employee pay?
  • Do they maintain employment records?

If you answer yes to any/all of those questions, it’s likely they shouldn’t not be allowed to participate in a tip pool or at least receive a tip from a fellow employee.

What would you say to employers who are unsure about their tip and/or service charge policies?

Take the initiative to understand what the laws are in your state and at the federal level. There’s a lot of change happening, and many of these laws vary from state to state (California has its own orbit!) so your policies need to keep pace. It’s never a bad idea to have legal counsel review and bless what you’re doing. And hour or two of review time can help you avoid millions of dollars in litigation.

When you’re putting a policy in place, consider running it by your managers. That’s a great way to get buy-in when you’re making a change to the way you’re compensating your team. And don’t blindside your employees. Be there to answer their questions.

This isn’t as much about compensation as it is about taking care of your employees — but don’t be resistant to technology. The pandemic has helped with that. A lot of employers are becoming more tech savvy. Technology can minimize the volume of work and stress your people are dealing with.

Do you have specific questions about the policies in place at your restaurant? You can reach Beth at bschroeder@raineslaw.com.

You might also be interested in

Kickfin’s best-in-class tip calculation tool has some exciting new bells and whistles.

If you’re already using Kickfin’s tip pool calculator, then you know how much time and hassle you’re saving by automating everything. (And if you’re not? Head over to our tip pooling software page to see how it works!)

As we partner with more restaurants to bring their tip management into the future, we’re continuing to innovate our product so we can address their biggest pain points.

In this case, that means enhancing our tip pooling features so you can auto-calculate tip amounts even for the most complex or unique tip pool or share policies.

Check out a few of our latest features that will make tip calculations easier than ever.

New Release: Splitting Large Party Tips 

If your restaurant often hosts large parties, you know that the tip share can get confusing. Say one server is taking care of a party of 40 with a bartender assigned to only make drinks for that party. Meanwhile, the server has a few other two-top tables that are getting drinks from the main service bar. At the end of the night, how do you ensure that the large-party bartender gets their fair share of the tip out (without spending an hour on your phone calculator)? 

Kickfin can now automate that process for you, alleviating questions from your event bartender and saving time and effort on the part of your managers. 

Seamless Integrations 

Kickfin is partnering with your POS system to integrate seamlessly with your existing restaurant tech. Already, we’re serving Toast customers through our integration — and your POS just might be up next. 

Kickfin integration users get access to new product features first, like our new tip-out transparency tool. Your employees can log into their Kickfin accounts and see exactly how their tips have been split between team members, offering them full transparency into your tip policy in action.

Manager Tips 

We’re always listening to feedback to improve the Kickfin experience, and this one goes out to all of our restaurant partners who asked us to streamline the manager tip reallocation process.

>>Learn more about managers & tipping laws

In most cases, managers are not allowed to earn tips since they are salaried employees. But we all know that managers often step in and take care of tables to help servers get out of the weeds. Well-meaning guests will most likely leave a tip, not knowing that the manager technically can’t accept them — so where does that money go?

Kickfin now features a default pool, where tips “paid” to a manager are automatically redistributed to tipped staff based on your restaurant’s tip policy. 

Improved Labor Data Accuracy

We all know how easy it is for an employee to forget to clock out after a long shift. And sure, they aren’t going to get paid for a 16-hour overnight shift, but when payday comes around, those extra hours create a nightmare for your payroll team. 

With Kickfin, all employees are required to be clocked out in order to finalize payments — so you’ll catch the labor data mistake long before your payroll team has to sort it out. 

Even Better Security 

We’re committed to protecting you and your employees’ hard-earned money, so we’re adding an extra layer of security for certain transactions. You can now enable double approval of payments that meet certain conditions:

  • First payment for new employees
  • Employees getting their first payout in X number of days
  • Employees receiving more than X payouts in a 24-hour period. 

With these extra guardrails in place, you can always be sure that the right money is going to the right person. Reach out to our support team to configure your custom security measures.

Using Kickfin is a win-win for operators, managers, and employees alike. Restaurateurs save on cash delivery and labor costs, managers shave hours off their workload, and servers have the same instant payment that they’re used to — without the hassle and uncertainty of cash. 

Want to learn more about Kickfin? Let us show you the ropes with a demo

You heard it here first: 2024 is the year of integrations. 

In an effort to make Kickfin even more user-friendly and adaptable for our partners, we’re working with restaurant tech leaders to integrate our tip management solution with their existing systems. 

First up — Toast! A trailblazer for cloud-based restaurant management technology, Toast is a favorite POS system for restaurants, food trucks, and bars. You probably know them best for being the first to create handheld POS devices, drastically changing the entire restaurant ecosystem. To make life easier for their customers, Toast partnered with Kickfin to create an integration that makes tip pooling, tip distribution, and calculation smoother. 

As restaurant tech innovators ourselves, this partnership is the perfect fit for Kickfin. 

Our goal at Kickfin is always to save time for managers, prevent loss for operators, and create more financial freedom for hospitality employees through pioneering technology that digitizes many of the analog processes that the restaurant industry is built on. 

As a member of the Toast Partner Ecosystem, we’ll be able to deliver our product to Toast customers and modernize their tip management systems with ease. Using technology that they’re already familiar with, Toast customers can reap the benefits of Kickfin with minimal ramp-up upon implementation.

“No two restaurants split tips the same way, but invariably, it takes too long and involves too much risk,”  said Justin Roberts, the co-CEO of Kickfin. “This integration allows for the utmost customization with a near-zero learning curve — truly the best of both worlds for restaurants that want to save time, reduce labor costs and make life easier for their team.”

And one of their partners is already enjoying the ROI with Kickfin. Bar Louie takes great pride in making tip distribution equitable for all of their employees, so they rely on a complex tip pooling system to ensure fair pay. Prior to using Kickfin, managers at each of their 60 locations spent 45 minutes at the end of every shift to make calculations and divvy out funds to all of their servers. Now, they’ve streamlined their tip-out process with Kickfin — and managers are doing the same work in less than a minute! That’s an annual average of 15,000 hours saved across their entire chain. 

>> Hear more Kickfin success stories

After implementing Kickfin, managers can spend their time on what matters most: delivering excellent customer service. That means more table touches, more support for your staff, and more time to focus on server training. 

With managers spending more time on the floor (instead of counting cash in the back), you’ll see better customer reviews, better service, and increased sales — all from digitizing your tip-outs with Kickfin.

We’re excited about our new partnership with Toast and the opportunity to make digital tipping a reality for their customers. For restaurants who aren’t using Toast, don’t worry! We look forward to providing similar integrations across the restaurant tech industry.  

Want to see these results for yourself? Find out how to become a Kickfin integration partner or check out a demo of our platform.

No growing pains here! 

We’re thrilled to announce that Inc. listed Kickfin in their list of the top 10 fastest growing companies in the Southwest. (In fact, we earned the #1 spot in the software category and were listed as #9 overall!) We’re honored to be included alongside innovative companies that are making a big difference in our region. 

Inc. measured Kickfin’s growth from 2020 to 2022 — which wasn’t an easy time for the restaurant industry, to say the least. In spite of the challenges posed by the pandemic, restaurant concepts across the country embraced Kickfin’s technology. 

As a group, the 2024 Inc. honorees averaged 136% growth and created 17,606 new jobs over a two-year period. Individually, Kickfin grew by a whopping 1,304% (yes, really!).

We want to recognize and thank both our amazing customers and the Kickfin team for being part of our success story and allowing us to be a part of theirs. 

Our Customers

For years, restaurants manually calculated and paid out cash tips — despite the increasing hassle and liability those old-school methods entail. It’s not because operators are tech-averse; there simply wasn’t a good way to automate the process that didn’t create new friction or require new workarounds. 

That’s precisely why we developed Kickfin. Of course, we’re proud of what we built and the team behind it (more on that below). But we owe a great deal of our success to the customers who trusted us enough to give Kickfin a shot — especially those early adopters who are now some of our longest-standing customers.

There’s a leap of faith involved when you partner with a vendor and layer in new technology, particularly when it impacts something as important and sensitive as how you pay your people.  We don’t take that lightly, and we are incredibly grateful for the opportunity to serve each and every customer who’s been on this journey with us.

>> Hear from our customers about their experiences with Kickfin

Our Team 

Every person on our team wholeheartedly believes in our mission and vision for the future. In short: we’re here to make the tip management process insanely easy for everyone so that paying out your people is (almost!) as great as getting paid. 

As backstory: Our co-founders, Brian and Justin, came up with the idea for Kickfin while dining out together and noticing that an armored car was dropping off cash. They asked why a restaurant would need a cash delivery when most patrons pay by card; the manager explained the cash was needed to pay out tips at the end of the shift. The inefficiency (and expense, and risk…) of that process was a lightbulb moment for Brian and Justin.

They set out to build a team who not only understood the problem, but could think critically and creatively about a solution — and bring it to life. 

From sales and marketing to product and support, every Kickfin employee has had a hand in the growth and success of our company, thanks to their passion for our purpose and their commitment to being best in class.

We’re proud of what we’ve achieved thus far, and we’re excited to continue collaborating with our customers, innovating on their behalf, and taking Kickfin to the next level together. Onward and upward!

It’s no secret that tax season is confusing and stressful, especially when you work in the hospitality industry. Many restaurant employees — whether they’re newbies or seasoned pros — aren’t exactly sure what’s required when it comes to reporting their income and filing taxes. There tends to be a lot of misconceptions particularly when it comes to reporting on tips received.

Maybe your employees are asking questions, or maybe you have a hunch that they should be asking questions. If that’s the case, we’ve taken the liberty of answering a few FAQs that your staff might find helpful. (Obligatory disclaimer: Of course, this is not intended to be tax, legal or accounting advice, and it’s always best to point them in the direction of a certified tax pro if they need help!). 

1. Do I have to report my tips to the IRS? 

Short answer: yes. 

Employees are required to report all income, including tips received while working at a restaurant, on their tax returns. This includes cash tips, credit card tips, and tips received via electronic payment platforms. 

Accurately reporting your income, including the tips you’ve earned, ensures that you avoid penalties and legal issues. But it’s not just about ensuring “Uncle Sam” gets his due; it also behooves you to avoid underreporting your earnings. More on that in a minute…

To make things easier, it’s advisable to keep detailed records of your tips to ensure accurate reporting come tax time. (If you’re a Kickfin user, of course, that’s easy to do!)

These days, you probably receive tips from customers in one of two ways: either they add a tip via credit card when they pay the bill, or they’ll leave a cash tip. Here’s what to know about reporting credit card tips and cash tips to the IRS

Reporting credit card tips

Most restaurants use POS systems to run their front-of-house operations. When customers leave tips on credit cards, they’re getting tracked in the POS and reported to the IRS by your employer. As a result, those tips are going to be included on the W-2 or 1099 that your employer gives you.

That’s because your employer is responsible for paying taxes on your tip earnings, too. In addition to paying payroll taxes, employers are required to withhold income taxes, Social Security taxes, and Medicare taxes on those employee tips, just as they would on other forms of employee compensation. They must keep accurate records of all tips reported by employees and include those amounts when filing employment tax returns.

(Keep in mind: this is the case for all tips left on credit cards, no matter how your employer is paying out those tips — cash, digitally, paycard or payroll. In other words, even if you’re leaving your shift with a wad of cash in your wallet, the IRS is well aware that you earned those tips, assuming your customers are primarily paying with credit cards.)

What’s more: because cash tips are less common and POS data is readily available, the IRS collects income information based on the credit card tips you input through their SITCA program. So, there’s really no way around reporting credit card tips to the IRS, and you’ll be liable for income tax on those tips. 

>> Learn more about SITCA and tip reporting

Reporting cash tips

This is where things can get a little muddy. 

It’s been common practice in the restaurant industry to under-report cash tips (or not report them at all). Technically, this is illegal. 

Bottom line: Employees are required to report all tips received when you file your taxes, including cash tips that were not run through your restaurant’s POS. Again, if you don’t accurately report your tip earnings, you could face financial and/or legal penalties. 

2. Does it affect my employer (and will they care?) if I under report my cash tips? 

Most restaurants are using the tip credit to decrease their monthly labor costs — so under reported tips could cause them some problems. 

Your employer’s biggest concern here is making sure that you earn at least minimum wage with the addition of your tips. If the majority of your tips are coming from credit cards, those are already automatically reported through your POS system, and your employer can track them for compliance purposes. But if you’re the rare server who earns more cash these days, then under reporting tips could cause a big spike in labor costs for your employer. 

In short, your employer probably won’t care if you don’t report all of your cash tips, but there are some serious reasons why you should…

3. What happens to me if I under report my cash tips? 

Leaving those cash tips untaxed might give you more freedom in the short run, but it could affect your future financial security. 

  1. You run the risk of being audited. No, it’s not super likely, but there’s always a chance that the IRS may be suspicious of your reported sales compared to your reported tips. This discrepancy could cost you in the long run.

  2. Unemployment and disability payments are based on wages. If you’re under-reporting your tips, it could hurt you if you ever need to rely on unemployment or disability (which many restaurant employees had to do during the pandemic). With your income artificially decreased, you’ll have to live off of much less than you’re actually owed.

  3. It may be harder to make investments in your future. We know great servers who are raking in the cash… but when you’re ready to make a major financial move, you might not have the documentation to back it up. For example, you might love a house that is technically in your budget, but without proof of your entire income, you might not qualify for a sizable enough home loan or be able to prove that you make three times the rent.

4. How does my tip reporting affect my taxes? 

Ultimately, how much you report in tips will determine how much you owe in taxes — that’s kind of the whole point of reporting your income. The more you report, the higher your tax liability. 

5. Why do I owe taxes every year? Aren’t they supposed to be withheld from my pay? 

They are — but your hourly wage probably isn’t enough to cover your entire tax responsibilities. You might remember picking up several $0 paychecks throughout the year. 

This isn’t necessarily a bad thing: many financial experts say that it’s actually better to owe taxes when you file. That means you had more freedom to invest throughout the year, and that you weren’t offering the government a loan that they have to pay back in April. 

But we get it. That big tax refund is way more fun to see hit your bank account, and you might not be prepared to pay up if you owe. If you’re afraid that you’ll owe taxes (or panicking about where you’re going to get the money to pay them), here’s what you can do to ease your burden. 

  • Set taxes aside each week. Even though you’re walking out with tips in hand (or in your bank account), that doesn’t mean they aren’t going to be taxed eventually. Each week, count up your tips and set 10-15% aside to save for tax season. If you have extra money leftover — take a vacation!

  • Explore write offs and deductions. Did you pay for your own uniform? Or for a safe alcohol service course? Are credit card fees taken out of your tips? All of these are deductions that you can use to reduce how much you owe.

  • Keep precise records. You’ll need to know how much you spent on work-related expenses and will need to back it up with documentation. If your employer is using Kickfin, your account is a great source of truth for all of your tip payout information. 

All of this reporting and recordkeeping can feel overwhelming — especially for servers who can’t remember how much cash they left with last night, let alone a year ago. Make sure your employees have all the tools they need to make smart financial decisions. Check out how Kickfin’s reporting can make life easier for managers and servers alike.

See Kickfin in action!