A tip credit lets an employer count part of a tipped worker's tips toward the minimum wage, so the restaurant pays a lower hourly cash wage. Federally the numbers have not moved in years, but state rules keep changing, and several of those changes land on January 1. If you operate in more than one state, or in a state that is phasing its tipped wage up, the payroll settings you used in 2026 may be wrong in 2027.
This guide explains how the tip credit works under federal law, what an employer must do to claim it, which states do not allow it at all, and what to check before the new year. The federal figures below come from the Department of Labor's Fact Sheet #15 and its state tipped wage table dated July 1, 2026. Confirm your own state's rate with the state labor office before you update payroll.
Under the Fair Labor Standards Act, a tipped employee is someone who customarily and regularly receives more than $30 a month in tips. For those workers, an employer may pay a direct cash wage of at least $2.13 per hour and take a tip credit of up to $5.12 per hour, which together equal the $7.25 federal minimum wage.
The credit can never exceed the tips the employee actually received. If a server's tips plus the $2.13 cash wage fall short of $7.25 for every hour worked in a workweek, the employer must pay the difference. That shortfall check happens per workweek, not per shift and not as a monthly average.
Most states set their own minimum wage above $7.25, and many set a higher tipped cash wage too. When state and federal rules differ, the employer follows whichever gives the employee more.
The easiest way to see the rule is to follow one server through a week. The figures below are illustrative and use the federal minimums only.
If the server reported $420 in tips that week, the tips cover the $153.60 credit easily and the restaurant pays only the cash wage. If a slow week brought in $110 in tips, the credit is limited to $110, and the restaurant owes an extra $43.60 to bring the week up to minimum wage.
That is why tip records by employee and by week matter. A POS that ties every card tip to the person who served the check, and asks for cash tip declarations at clock-out, gives payroll what it needs to run this test automatically. Without it, a slow Tuesday-through-Thursday stretch can leave you underpaying without noticing.
The tip credit is not automatic. Fact Sheet #15 says an employer must tell each tipped employee, before taking the credit:
The notice can be oral or written, but a written version signed at hiring is far easier to prove later. Restaurants with bilingual teams should give the notice in the language each employee reads best. If you have never documented this notice, the safest correction is to give it now and keep the signed copies with your onboarding records.
Two more conditions affect the credit. Managers and supervisors may not keep any portion of employees' tips. And a tip pool can include only customarily tipped employees when the employer takes a tip credit; including cooks or dishwashers in that pool means the employer must pay the full minimum wage to everyone in it. Our guide to restaurant scheduling tools covers how to keep role-based hours clean, which supports both rules.
According to the Department of Labor's state table dated July 1, 2026, these states require employers to pay the full state minimum wage before tips:
Guam also requires the full minimum wage. If you operate in one of these states, the tip credit does not apply to you at all, and your server's hourly rate on the paycheck is the full state minimum or more.
Many local governments set their own minimum wages as well. Chicago, for example, is phasing out its tip credit over several years. Check city and county rules where each of your locations sits, not only the state rate.
A few states are in the middle of multi-year changes to tipped pay:
Because many states announce indexed rates in the fall, the right move in November is to look up the January 1, 2027 rates for each location and schedule the payroll change for the first pay period that includes January 1. Our minimum wage by state page is a starting point; the state labor office is the final word.
For a few years, the Department of Labor enforced a rule that limited the tip credit when tipped employees spent more than 20% of their time, or more than 30 straight minutes, on supporting work such as rolling silverware or restocking. On August 23, 2024, the U.S. Court of Appeals for the Fifth Circuit vacated that rule in Restaurant Law Center v. Department of Labor.
The result is that employers no longer have a federal obligation to track minutes spent on side work within a tipped job. Work that falls clearly outside the tipped occupation, such as a server spending a shift as a prep cook, still should not be paid at the tipped rate. Some states and localities have their own versions of the 80/20 idea, so check local rules before you drop any time-tracking you already do.
In practice, the cleanest approach is to give employees a separate job code for non-tipped work. When a server picks up a prep shift, they clock in under the prep role at the full wage, and the POS keeps those hours and any tips apart.
The federal "no tax on tips" deduction that started in 2025 is a separate rule. It changes how employees treat qualified tips on their income tax returns, and it adds tip reporting fields to the W-2. It does not change the $2.13 cash wage, the $5.12 maximum credit, or any state tip credit rule.
The two rules do share the same data, though. Accurate tip totals by employee and job code support the weekly minimum wage test for the tip credit and the year-end W-2 reporting for the deduction.
The Chowbus POS keeps staff permissions, roles and exportable timesheets in one place, which makes the job-code and shortfall checks easier to run across locations.
Q1: What is a tip credit?
A tip credit is the portion of a tipped employee's tips that an employer counts toward the minimum wage. Under federal law the employer pays at least $2.13 an hour in cash and may take up to $5.12 an hour as a credit, for a total of $7.25. The credit can never exceed the tips actually received.
Q2: How do I calculate whether a tipped employee made minimum wage?
For each workweek, multiply hours worked by the applicable minimum wage, then compare that amount with the cash wage paid plus tips received. If cash wage plus tips is lower, the employer pays the difference. Run this test every week, not as a monthly average.
Q3: Which states do not allow a tip credit?
According to the Department of Labor's July 1, 2026 table, Alaska, California, Minnesota, Montana, Nevada, Oregon and Washington require the full state minimum wage before tips, as does Guam. Some cities set their own rules, so check local law for each location.
Q4: Is the 80/20 rule still in effect?
The federal 80/20 rule was vacated by the Fifth Circuit on August 23, 2024, so there is no longer a federal requirement to track side-work minutes within a tipped job. Some states and localities have similar standards, and work clearly outside the tipped job should still be paid at the full wage.
Q5: Can a restaurant take a tip credit if cooks share in the tip pool?
No. When an employer takes a tip credit, the tip pool may include only employees who customarily and regularly receive tips, such as servers, bussers and service bartenders. Pools that include cooks or dishwashers are allowed only when the employer pays everyone in the pool the full minimum wage.
Q6: What should restaurants update before January 1?
Update minimum and tipped wage rates for each location, reissue the written tip credit notice with the new amounts, confirm tip pool membership, and give non-tipped work its own job code. Then run the weekly shortfall test closely during January, when slower weeks make shortfalls more likely.
The tip credit saves restaurants real money in the states that allow it, but only when the paperwork and the weekly math are in place. A signed notice, accurate tips by employee and clean job codes are what make the credit hold up if it is ever questioned.
With several states changing rates on January 1, November is the right time to confirm each location's numbers and schedule the payroll update. A short review now prevents a back-pay problem later.
