Takeaway: Imposition of a service charge can provide certain employers with greater flexibility in their payroll. However, it is important to remember that it may be used only by employers whose employees are compensated well above the statutory wage rate and only if more than half the employees’ compensation represents commissions on goods or services.
A mandatory service charge applied to diners’ final bills was not a “tip” and is properly considered part of employees’ regular rate of pay, allowing the employer to use those payments to satisfy its wage obligations under the Fair Labor Standards Act (FLSA) overtime exemption, the 11th U.S. Circuit Court of Appeals ruled.
The employer, an upscale steakhouse in Miami, charged customers an 18 percent service charge, which was added to their final bill. Customers could also add a voluntary, discretionary gratuity by writing in the desired amount on the final receipt or by leaving cash tips. The service charge, however, was non-negotiable.
From November 2017 through April 2018, employees were paid an hourly rate, an overtime wage and a pro rata share of the collected service charges. Service charge payments were processed through a point of sale system and distributed to employees using a point system to give each employee a prorated share of the total, minus 2.65 percent for credit card processing fees. The employer also distributed the additional gratuities to tip-eligible employees.
This pay structure changed slightly on April 30, 2018, when the restaurant eliminated the hourly rate for employees and instead satisfied its wage obligations exclusively through the service charges. The employer claimed the new pay structure was lawful under 29 U.S.C. § 207(i), which exempts certain employers from paying overtime wages if: 1) the regular rate of pay of such employee is in excess of 1 1/2 times the minimum hourly rate and 2) if more than half the employee’s compensation for a representative period represents commissions on goods or services.
Florida’s minimum wage between 2017 and 2019 ranged from $8.10 per hour to $8.46 per hour. During this period, the employer paid its employees amounts ranging from $23.68 to $51.58 per hour.
In January 2019, a group of tipped employees challenged the employer’s compensation scheme in a collective action brought under the FLSA. They alleged that from Nov. 1, 2017, through Jan. 18, 2019, the restaurant paid them less than the required federal minimum and overtime wages and forced them to participate in an illegal tip pool with nontipped employees.
Although the plaintiffs’ portion of the service charges exceeded the statutory wage requirements, with some employees earning over $100,000 per year, they argued that the employer was in violation of the FLSA because the 18 percent service charge was, in fact, a tip. They argued that because tips are not part of the employees’ regular rate of pay, the restaurant could not use them to offset its wage obligations under the FLSA.
The employer requested summary judgment, arguing that the 18 percent fee was a bona fide service charge and that the undisputed record showed the employees were compensated well above the statutory wage rates. The employer contended that the critical feature of a tip is that the decision to pay a tip is entirely within the customers’ discretion, while service charges are mandatory. The district court granted summary judgment to the employer, and the employees appealed.
On appeal, the 11th Circuit found the service charge was not a tip under the FLSA and was part of the employees’ “regular rate of pay,” which refers to the hourly rate actually paid to the employees for the normal, non-overtime workweek for which the workers are employed. The court noted that the FLSA does not define “tip” or “service charge.” However, Department of Labor (DOL) regulations state that the critical feature of a “tip” is that “whether a tip is to be given, and its amount, are matters determined solely by the customer.”
“By this measure, [the employer’s] service charge is not a tip,” the appeals court held, stressing that the decision of whether and how much to pay are not determined by the customer at all. Bolstering its finding, the court cited another DOL regulation that provided examples of amounts not received as tips and explained that “a compulsory charge for service … imposed on a customer by an employer’s establishment, is not a tip.”
The court also noted that because the service charges were not tips, it is irrelevant whether the employer paid some of that money to nontipped employees.
The employees argued that a service charge is a tip unless an employer includes the service charges in their gross receipts for tax purposes. They claimed the employer failed to show that it included the service charges in its federal tax returns, creating an issue of fact as to whether the service charge is a tip.
The employer’s tax forms are irrelevant, the court ruled. Evidence shows the employer recorded the service charges in its point of sale system before redistributing them to employees, thus including them in its gross receipts, the court said. Further, it found no statutory requirement that an employer include a service charge in its gross receipts for tax purposes to avoid treating it as a tip.
Finally, the employees argued the service charge was not mandatory because managers had discretion to remove the charge on the bills of dissatisfied customers. “What the employees miss is that the relevant question is whether the decision to pay the given sum is determined solely by the customer,” the court responded. “Here, it is not. The customers had no ability to determine on their own whether they would pay the service charge. It is irrelevant that managers would sometimes remove the service charge for dissatisfied customers.”
The 11th Circuit, finding that the service charge was a bona fide service charge and not a tip because it was a “compulsory charge for service” and the decision to pay it—and the amount to pay—were not determined solely by the customer, affirmed the district court’s summary judgment order.
Compere v. Nusret Miami LLC, 11th Cir., No. 20-12422 (March 18, 2022), petitions for rehearing and rehearing en banc denied (May 25, 2022).
Rosemarie Lally, J.D., is a freelance legal writer based in Washington, D.C.