The Tip Credit Decision: Balancing Labor Costs with Compliance Risk

For many hospitality businesses—especially those in full-service restaurants—deciding whether to take the tip credit is one of the most important compensation decisions they’ll make. In states where it’s legal, using the tip credit can significantly reduce labor costs. But it also comes with real tradeoffs, especially as guest expectations, team culture, and compliance risks continue to evolve.

So, should you take the tip credit? The answer depends on your concept, your team, and your long-term strategy. To help you decide, this article covers the pros and cons of the tip credit, a key component of hospitality compensation, so you can make an intentional choice.

What Is the Tip Credit?

In states where it’s permitted, the tip credit allows employers to pay tipped employees a tipped minimum wage—a rate less than the standard minimum wage—if tips bring their earnings up to the legal minimum.

For example, if the minimum wage is $15/hour and the allowable tip credit is $5/hour, a business may pay eligible employees $10/hour—provided their tips bring them to or above $15/hour.

Although the tip credit is commonly associated with full-service restaurants, it can also apply to fast casual, counter-service, and hybrid concepts where employees regularly receive tips. However, eligibility and rules vary significantly by state and locality.

Benefits of Taking the Tip Credit

Lower Restaurant Labor Costs

Using the tip credit legally reduces your direct wage obligations, which can provide critical relief in high-labor-cost markets.

Flexible Compensation

Tipped employees typically still earn strong overall wages, and some prefer the earning potential that comes with tip-based roles.

Margin Management

In tight-margin business models like fast casual or counter service, reducing base wage costs can create financial flexibility.

Challenges and Risks of Taking the Tip Credit

1. Tip Credit Compliance Complexity

Operators must meet strict legal requirements, including providing proper written notice, tracking tips, and limiting non-tipped work.

One of the most important rules is the 80/20 rule for tipped employees, which states that a tipped employee may only spend up to 20% of their total weekly hours on non-tip-producing work (such as side work or cleaning) while still receiving a subminimum wage. If that threshold is exceeded, the employee must be paid the full minimum wage for those hours.

1. Legal Exposure

A tip credit violation is among the most common sources of wage and hour claims. Even small missteps—like misclassifying duties or failing to give proper notice—can result in costly legal action.

1. Role Ambiguity

In many fast casual or hybrid concepts, employees float between service and non-service tasks, making it difficult to confidently apply the tip credit.

1. Impact on Culture and Equity

Compensation imbalances between tipped and non-tipped roles can create morale challenges, especially in team-driven environments where responsibilities overlap.

1. Administrative Burden

Managing compliance with tip credit rules requires reliable systems, accurate time tracking, and well-trained managers. This becomes increasingly complex at scale or across multiple jurisdictions.

Alternatives to the Tip Credit

While the tip credit can be a valuable tool, it isn’t the only approach to managing labor costs and compensation in hospitality businesses. Alternatives include:

Pay Full Minimum Wage (or More)

Some employers choose to pay the full minimum wage or higher, regardless of tips. This approach simplifies compliance and payroll and can help support retention and equity across teams.

Use the Tip Credit Selectively

Operators may apply the tip credit only to certain roles with consistent tipping, while paying others a full wage. This hybrid approach helps reduce exposure while preserving some labor cost savings.

Note: While service charges are sometimes used to rebalance pay, they are not legal or practical in all jurisdictions. Operators should consult legal counsel before implementing this approach.

Tip Credit Compliance Summary

If you decide to take the tip credit, these are the key federal compliance requirements to follow:

This table reflects general federal rules. Always verify with local and state laws before making decisions about tip credit eligibility and use.

Evolving Legislation: Washington, D.C. as a Case Study

Legislation surrounding the tip credit is not static; it evolves in response to economic pressures, political climates, and public sentiment. A notable example is Washington, D.C., where legislative changes like Initiative 82 in DC have significantly altered the landscape for tipped employees.

Initiative 82 and Its Amendments

In 2022, D.C. voters approved Initiative 82, a measure aimed at gradually eliminating the tipped minimum wage to align with the standard minimum wage by 2027. However, in July 2025, the D.C. Council amended this initiative, freezing the tipped minimum wage at $10 per hour through July 2026. Subsequently, the wage is set to increase gradually to 75% of the full minimum wage by 2034, rather than achieving full parity as originally intended.

This amendment has sparked debate between labor advocates, who view it as a betrayal of voter intent, and business groups, who see it as a necessary compromise to support the struggling restaurant industry.

Impact on the Hospitality Industry

These legislative changes in D.C. underscore the dynamic nature of tip credit laws and their direct impact on the hospitality industry. Operators must stay informed about local and state regulations, as shifts in legislation can have profound effects on compensation structures and operational strategies.

The “No Tax on Tips Act”: Implications for Employees and Employers

In July 2025, the U.S. government enacted the “No Tax on Tips Act,” a provision within the broader “One Big Beautiful Bill” (OBBB) aimed at providing financial relief to tipped workers by exempting a portion of their tip income from federal income taxes.

Key Provisions of the Act

• Deduction Limit: Eligible employees can deduct up to $25,000 in cash tips from their taxable income, provided their annual earnings do not exceed $160,000.

• Eligibility Criteria: The deduction applies to workers in occupations that traditionally and customarily receive tips, such as servers, bartenders, and delivery drivers.

• Tax Implications: While the deduction reduces federal income tax liability, it does not exempt tip income from other taxes, including Social Security, Medicare, state, and local taxes.

• Expiration: The provision is temporary, set to expire at the end of the 2028 tax year.

What This Means for Employers and the Tip Credit Decision

While this tax provision improves take-home pay for tipped employees, it does not change the legal or operational requirements that employers must follow when using the tip credit. Employers are still responsible for ensuring compliance with wage and hour laws, managing payroll complexities, and deciding whether the tip credit makes sense for their business model and team.

In other words, the No Tax on Tips Act benefits employees directly by reducing their tax burden but does not affect how employers decide to apply the tip credit or pay minimum wages.

Finalizing Your Tipped Employee Compensation Strategy

Taking a tip credit can be a useful labor strategy—but only if it aligns with your operational model, tip credit compliance capabilities, and team culture. For others, the risk of a tip credit violation, the administrative burden, or the cultural misalignment makes it a less viable option. For some hospitality businesses, it provides needed flexibility. For others, the legal exposure, administrative burden, or cultural misalignment makes it a less viable option.

The best approach is to evaluate your service model, your team structure, and your compliance readiness—and make a clear, intentional choice based on your business goals.

This article is intended for general informational purposes only and does not constitute legal, tax, or accounting advice. You should consult qualified professionals regarding your specific situation. No guarantees are made about the accuracy or completeness of the information, and it should not be relied upon for decision-making. If you need help navigating your compensation strategy, contact the experts at Empowered Hospitality today.