Tip v. Mandatory Service Charge

In a ruling issued in June 2012 the Internal Revenue Service clarified the difference between a tip and a service charge for tax purposes under the Federal Insurance Contributions Act. The IRS determined that automatic gratuities (a percentage automatically added to a restaurant bill) are service charges, rather than tips for tax purposes. Revenue Ruling 2012-18 also determined that to the extent any portion of a “service charge” is distributed to an employee, it is wages for FICA tax purposes.

Generally, the burden of reporting tips falls on the employee. Employees that receive more than $20 in cash tips (cash, debit/credit cards) per month are required to report the tips to their employers by the 10th day of each month. The employer is then required to withhold FICA taxes, similar to non-tip wages. An employer is not liable for their share of FICA taxes if the employee fails to report tips.

However, effective January 1, 2014, employers are required to treat mandatory gratuities as “service charge wages” instead of tips. This directly affects an employer’s responsibility to report and pay FICA taxes, as well as, overtime calculations.

Under the new guidelines, the IRS stated that the difference between a tip and wage requires a factual determination considering all the circumstances. The IRS will generally categorize a payment as a tip (versus a wage) when: (1) the payment is made free of compulsion; (2) the customer retains the right to determine the amount; (3) payment is not subject to negotiation or employer policy; and, (4) the customer determines who gets payment.

As a result, automatic gratuities or service charges are no longer considered tips. Customers do not have a choice whether or not to leave a gratuity and are forced to leave a specified amount set by the employer. Such mandatory gratuities when distributed to the employee by the business are considered wages. As wages, they are not eligible for the FICA Tip Credit (The 45B Credit). For many years, restaurants have benefited from being allowed to apply a general business credit toward a portion of the employer’s social security and Medicare taxes paid on tips in excess of the federal minimum wage as of Jan. 1, 2007.

Also, since automatic gratuities and service charges are not tips, they cannot be included in the tip amount that social security and Medicare taxes are paid on, which takes some tax credit off the table for restaurants. This credit is claimed on Form(s) 8846 and 3800.

However, where a restaurant provides a customer a receipt with recommended tipping amounts i.e… 15%, 18% and 20%, the IRS does not classify the amount left as wages because the customer has a choice to determine the amount, is free from compulsion and determines the amount of the gratuity, if any, left. Therefore, this situation would support a finding that this is truly a tip and not considered wages.

Absent choice by the customer, an automatic gratuity when paid by the restaurant to the employee is considered part of the employee’s wages. This means the burden rests on the employer to incorporate automatic gratuities as part of the employee’s wages as opposed to relying on the employee to report their tips. Service charges/automatic gratuities are considered part of the employees’ overall rate of pay. As such, where a member of the staff works over 40 hours in week or 8 hours in a day in some states like California and receives a portion of the automatic gratuities, this amount must be factored into the total wages earned and factored into that day’s or week’s regular rate of pay (i.e. total wages ÷8 or ÷ 40). It is this figure that is used to determine the overtime rate of pay (1 ½ times the regular rate of pay) for any overtime earned.

This means employers now have the additional burden make sure their pay systems calculate automatic gratuities as part of employees’ wages and use them to determine the regular rate of pay for a particular day or week for purposes of correctly calculating overtime. As such, employers must pay close attention to avoid the underpayment of overtime wages.

History of Federal law as to Tip Pooling

Historically, the federal law on tip pooling adopts standards which are protective of employees’ right to tips.

The Fair Labor Standards Act (FLSA) permits employer-mandated tip pools among employees who “customarily and regularly” receive tips, such as waiters, waitresses, bellhops, bussers and service bartenders. The interpretation made clear that employees who did not directly interact with customers such as chefs, cooks, janitors, and dishwashers were not allowed to share in the money contributed to a tip pool. A court in one case has held that hosts and hostesses who greet customers and perform some table attendance duties might be included in a tip pool. However, this holding was not all encompassing so a case-by-case analysis needed to be applied to determine applicability.

The FLSA forbids any arrangement where any part of the tip received becomes the property of the employer. A tip is the sole property of the tipped employee or employees appropriately participating in the tip pool.

The Department of Labor (DOL) also mandates that the pooling arrangement must be “customary and reasonable” and can not require an employee to contribute a greater percentage of their tips other than what is customary and reasonable. Although there is no definition or exact percentage of what the DOL deems “customary and reasonable,” the wage and hour division has found in cases where contributions of 15 percent or less of an employee’s tips to be acceptable. Contributions of greater than 15 percent are not statutorily forbidden but may require the employer to show that such a percentage is “customary and reasonable” for that community.

States also have similar definitions of allowable tip pooling. An issue of much interpretation and debate is whether employers may mandate that tips/gratuities be pooled and distributed among certain employees as a mechanism for ensuring that gratuities are shared by all employees in the “chain” of customer service and the chain of service over time in the restaurant industry has come to include all non-management employees in states where a tip credit is not permitted..

Pooling tips for redistribution is not required, nor is a written agreement or policy required to allow a tip pool.

“Chain of Service” Eligibility

However, the definition of “chain of service” has continued to be refined and evolve with opinions both by federal and state wage and hour divisions and the courts. For example, in 2005, California’s Department of Labor Standards Enforcement issued an opinion regarding tip pools stated that employees eligible to participate in a tip pool included anyone who contributes to the “chain of service bargained for by the patron, pursuant to industry custom.” This opinion letter described the “chain of service” to include bussers, bartenders, hostesses, wine stewards and front-room chefs (e.g., chefs at a sushi bar or who prepare food at the patron’s table). The opinion reaffirmed that no employer or agent with the authority to hire or discharge any employee or supervise, direct, or control the acts of employees may collect, take, or receive any part of the gratuities intended for the employees as their own. In other words, despite any tip pool container as is often seen at coffee shops, the owner(s), manager(s), or supervisor(s) of the business can not participate in the tip pool, even if these individuals provide direct table service to a patron. This is the case even if the guest intended to leave the tip for an owner, manager, supervisor, or agent of the business who actually provided service to the patron. Given the broad definition of the Labor Code, an agent could include a floor manager or shift supervisor if that person has the ability to direct or control the acts of employees.

However, recent court decisions have allowed shift supervisors in certain situations to share in gratuities. This situation was dealt with in lawsuits by Starbucks baristas as to company’s practice of permitting shift supervisors to share tips. At the Starbucks stores, the collective tip box was divided among the entry-level employees and the shift supervisors. A trial court in San Diego, California initially ruled that California law prohibited managers and supervisors from sharing such tips and awarded over $105 million dollars in damages. However, this decision was reversed with the Court of Appeals holding that shift supervisors are eligible to share in the tip pool, reversing the lower court decision. The Court found that shift supervisors performed the same tasks as baristas because their primary duty was to serve food and drinks. Chau v. Starbucks, Corp. 174 Cal App 4th 688 (2009). This case has not been overturned and even other states including New York cited to the Chau case to support allowing shift supervisors to participate in the tip pool based on their duties being more akin to baristas. See, Barenboim v. Starbucks Corp., 2013 N.Y. Slip Op. 04754 (June 26, 2013) wherein New York highest court found given that shift supervisors performed the same duties as baristas that they could share in the tip pool. Therefore, there seems to be consistency among states as to the role of shift supervisors working at Starbucks. However, consistently courts have found assistant store managers should not be included in the tip pool because they have too many managerial duties, including hiring and firing, so as not to be classified as staff…

These cases have also brought up the concept of a customer service team (consisting of one or more entry-level and one or more shift supervisors) who rotated jobs throughout the day and spent most of their time performing the same customer service tasks, thereby supporting the Starbucks tip pooling arrangement. Generally, a customer who places a tip in a collective tip box was found to understand that it would be shared by all service employees and these cases appear to be guiding law.

As to tip pooling, the industry has adopted a standard that distributes the majority of the pooled gratuities to waiters and waitresses, followed by a smaller percentage to bussers, and a still smaller percentage to other categories of employees who provide limited direct table service. There is no specific cap placed on the percentage of tips waiters and waitresses can be compelled to “tip out”. As will be explained below, the current state of the law has clarified who can participate in a mandatory tip pool.

Tip Credit and Tip Pooling subject to Attack

The most recent issue that has arisen involves who can share in the tip pool and whether “back of the house” employees like dishwashers, food scrapers, chefs, and cooks can share in the tip pool. For years especially under the Obama Administration, the Department of Labor (“DOL”) has consistently taken the position that employees who do not provide direct service to the customer are not allowed to participate in a tip pool. This would mean that kitchen staff who do not have direct service contact would not be viewed as being valid participants to share in a tip pooling arrangement.

However, inconsistent interpretations of the FLSA among various appellate courts have created confusion for both employers and courts regarding the applicability of valid tip pools. In early 2010, when the Ninth Circuit Court of Appeals (which covers the states of California, Nevada, Oregon, Washington, Arizona, Alaska, Idaho, Montana and Hawaii) held that an employer could require servers to pool their tips with non-tipped kitchen and other “back of the house staff,” so long as a tip credit was not taken and the servers were paid minimum wage. Cumbie v. Woody Woo, Inc., 596 F.3d 577 (9th Cir. 2010). According to the court, nothing in the text of the FLSA restricted tip pooling arrangements when no tip credit was taken; therefore, because the employer did not take a tip credit to reach the minimum wage, the tip pooling arrangement did not violate the FLSA.

In response, the DOL on April 5, 2011, issued new regulations that directly conflicted with the holding in Woody Woo. In early 2012, the DOL clarified its position on tip pooling by fully rejecting the Ninth Circuit’s decision in Woody Woo. Therefore, employers could no longer require mandatory tip pooling with back of the house employees. In conjunction with this announcement, the DOL issued an advisory memo directing its field offices nationwide, including those within the Ninth Circuit, to enforce its rule prohibiting mandatory tip pools that include such employees who do not customarily and regularly receive tips.

As a result, several restaurant trade groups and Wynn Las Vegas challenged the 2011 rule change in separate cases, seeking to enjoin its enforcement. (The plaintiff employers all required their employees to participate in a tip pool that included both tipped and non-tipped employees, and they did not take a tip credit against the minimum wage.) Both federal district courts concluded that the DOL lacked authority to make the rule change as a result of Woody Woo and, moreover, that the substance of the DOL’s revision contradicted Congress’ clear intent.; therefore upholding Woody Woo and allowing a mandatory tip pool with back of the house employees states where a tip credit was not allowed..

In response, the DOL appealed but set forth language that it would not seek to enforce these 2011 new regulations within states located in the Ninth Circuit area of responsibility that do not allow a tip credit. On February 23, 2016, a sharply divided panel of the Ninth Circuit Court of Appeals (which covers the states of California, Nevada, Oregon, Washington, Arizona, Alaska, Idaho, Montana and Hawaii) ignored its prior precedent issued in 2010 and upheld the 2011 DOL rule change. The majority concluded that the Fair Labor Standards Act’s (FLSA) “clear silence as to employers who do not take a tip credit has left room for the DOL to promulgate the 2011 rule and rejected the notion that the appeals court itself had foreclosed the agency’s ability to do so by virtue of its 2010 decision in Cumbie v. Woody Woo, Inc., 596 F.3d 577 (9th Cir. 2010). This decision meant that even in states where no tip credit exists that employers can no longer mandate a tip pool distribution that includes employees who are not in the chain of service or have direct contact with customers i. e. cooks, dishwashers… Oregon Restaurant and Lodging Association v. Perez, 816 F.3d 1080 (9th Cir. 2016)).

A petition for rehearing en banc before the full panel of Ninth Circuit judges, rather than the usual three, was requested. On September 6, 2016, the Ninth Circuit denied the petition but ten of the judges joined in a sharply worded dissent that laid out a path for an appeal to the U.S. Supreme Court. The Oregon Restaurant decision is directly at odds with the Fourth Circuit Court of Appeals decision in Trejo v. Ryman Hospitality Props., Inc., 795 F.3d 442 (4th Cir. 2015). Due to this “circuit split”, the National Restaurant Association, the National Federation of Independent Business and other hospitality groups filed briefs to join the Wynn’s prior petition for U.S. Supreme Court to decide whether the DOL acted within its statutory authority when it barred restaurants from including kitchen staff in tip pools. This appeal still is pending with the U.S. Supreme Court and a decision as to whether it elects to take this appeal and resolve the split in the federal courts of appeal is still outstanding

New Federal Budget allows Tip Pooling

In response to the DOL rule adopted under President Obama, the Trump DOL proposed a new rule which would allow tips to be shared and pooled between all employees. Even though this would allow some of the lowest paid employees to receive additional monies from sharing in tips, labor groups opposed the proposed new rule claiming this would result in employers’ managers or supervisors taking tips away from employees. The DOL extended the comment period to address these concerns.

On March 22, 2018, a compromise was reached as part of the omnibus budget bill signed by President Trump on March 23, 2018. Under a rider to the bill, now law, the FLSA is amended to allow mandatory tip pooling so long as the workers are paid at least the minimum wage. This is not an issue in California as a tip credit is not allowed and all employees must be paid at least the applicable minimum wage. Also the rider includes a provision reinforcing the rule that already exists in California that do not allow employers to keep “tips received by its employees for any purposes”. As a result, it reinforces the California rule that the agent of the employer i.e. owners, managers, supervisors are not permitted to share in a tip pool.

In summary, the new budget makes it clear that all employees can share in a tip pool and no longer excludes the heart of house employees like dishwashers, cooks and other kitchen staff. This new rule will help close the large wage gap between front of the house and back of the house workers. Finally, the new FLSA rule does not allow, and has never allowed, restaurant owners to keep employees tips. The tips belong to the nonsupervisory employees, even if the employer helps serve meals and interacts with customers

Practical guidelines for compliance

As a result the new FLSA rules, a company that pays all of its employees at least the minimum wage can l impose a tip pool that allows all non-management employees even those who are not directly in the line of service to be a part of a tip pool arrangement. “Back of the house” employees like cooks, kitchen staff and dishwashers can also share in the tip pool. It is unclear if the U.S. Supreme Court will take the pending appeal given this action as the new rule may have made the appeal no longer necessary.

Going forward, employers should take the following steps to limit liability on tip pooling claims:

A mandatory tip pool can include all line employees even those with limited customer contact as the law has evolved to recognize these employees as being a part of the chain of service for the industry.

If a mandatory tip pool is instituted, the employees with the greatest amount of customer interaction should get the largest percentage of the tips. It is important to make sure that the tip pool is distributed to participating employees in a reasonable manner, proportionate with the employees’ direct interaction with the customers.

Rely more on what the employee actually does in his/her job versus a job title. For example, an employee carrying the title of “waitress” whose only job is to prepare food outside the view of patrons or without personal contact with patrons should receive a smaller percentage of the tip pool. Also an employee who has greater contact with the customer should receive a greater percentage of the tip pool than employees who have less direct interaction with the patron.

It is illegal for the employer to share in the tip pool and therefore, do not distribute any portion of a tip pool to any owner, manager or supervisor, even if the owner manager or supervisor provides direct table service and/or the tip was left by the patron specifically for that individual.
Finally, if a tip pool is instituted, please make sure the tip pool is distributed to participating employees in a reasonable manner, proportionate with the employees’ direct interaction with the customers. It is important to review your current tip pooling arrangement, if you have one and revise it as needed to comply with the new rules.

For more specific questions as to prevention and allowable tip pooling policies, it is important to consult competent legal counsel who understands both the hospitality industry and wage and hour issues and can analyze those issues given your specific circumstances and policies.

In 2006, Nation’s Restaurant News described tip pooling lawsuits as “this year’s ‘in vogue’ class-action claim in California” (Jennings, 2006, p. 3). Fast forward to 2013 and it is clear that California is far from alone. Recent decisions from courts in Massachusetts and New York resolve the interpretation of previously untested language in their respective state statutes regulating tip pooling. Both cases involved class action lawsuits targeting Starbucks’ corporate policies regarding which employees are eligible to participate in the pool of accumulated tips. Indeed, the nationwide level of class action lawsuits over improper tip pooling arrangements is so high it is identified as a “key area to watch” in the 2013 Edition of the Annual Workplace Class Action Litigation Report (Maatman, 2013, p.8). Before examining the new developments resulting from the Massachusetts and New York cases, it is important to understand the broader context in which tipping occurs along with its regulatory environment and the reasons underlying the use of class action lawsuits against employers for alleged violations.

Broader Context of Tipping

The practice of tipping dates to 18th century England with its roots in the United States traced to post Civil War European travel by “wealthy Americans” who returned from their trips abroad continuing to tip here as a way to “flaunt their worldliness” (McConnell, 2009, pgs. 622-623). In modern times, rather than being a cultural indicator of worldliness, tipping has taken on a measure of “economic significance” (Azar &Tobol, 2008, p. 246.). On an annual basis, tips paid in the U.S. food service industry are estimated to be approximately $44 billion with millions of employees earning a significant portion of their income in the form of tips (Azar & Tobol, 2008, p. 246).

Regulatory Environment

With tips taking on a greater importance as part of employee income, it is not surprising that tip related issues became subject to both federal and state regulations. On the federal level, this occurred in 1966 when Congress did two things. First, it included restaurant workers in the group of employees protected under the Fair Labor Standards Act (FLSA) which, among other things, establishes minimum wage rates. Second and more directly germane to modern lawsuits over improper tip pooling:

…Congress adopted the concept of a tip credit which allowed employers to credit an employee’s tips to satisfy the federal minimum wage requirement. Along with the tip credit, Congress adopted the practice of tip pooling among customarily and regularly tipped employees which allowed employees to pool their tips together. Tip pooling was a method of ensuring fairer distribution of tips and promoting harmony among employees (McConnell, p. 623).

These new regulations negatively impacted employers by drawing more of their employees under the coverage of the federal minimum wage. However, this was mitigated by the tip credit provisions which permitted them to use tips paid to employees as an offset to meeting the required minimum hourly wage. Tip pooling facilitated the sharing of tips among all eligible employees which minimized the likelihood some tipped employees might not, of their own accord, earn enough in tips to reach the required minimum wage. This was of concern to employers because under the FLSA, employers must make up the difference when individual employee’s hourly wage ($2.13/hour) plus tips does not add up to the required minimum wage of $7.25/hour (“Fact Sheet #15: Tipped Employees Under the Fair Labor Standards Act (FLSA),” 2011).

Like many other areas of law, in addition to the federal requirements, states also regulate tip related issues. Consequently, businesses employing customarily tipped employees must comply with both the federal law as well as the laws of the state or states in which they operate. As a result, for example, if a state has a minimum wage rate higher than that set by the federal government; employers in that state must meet the higher state rate. Further, while many state laws regulating tips follow the model of the federal law by allowing employers to utilize a tip credit to meet the minimum hourly wage, some do not. The states that do not allow an employer to use a tip credit to satisfy the minimum wage include: Alaska, California, Minnesota, Montana, Nevada, Oregon, and Washington (McConnell, 2009, p. 638).

Tip Pool: The requirement that an employee must retain all tips does not preclude a valid tip pooling or sharing arrangement among employees who customarily and regularly receive tips, such as waiters, waitresses, bellhops, counter personnel (who serve customers), bussers, and service bartenders. A valid tip pool may not include employees who do not customarily and regularly receive tips such as dishwashers, cooks, chefs, and janitors  (“Fact Sheet #15: Tipped Employees Under the Fair Labor Standards Act (FLSA),” 2011).

While the FLSA is silent on the question of whether or not an employer can require tipped employees to share tips with other employees, some state laws permit such employer mandates while others only permit tip pooling arrangements voluntarily adopted by affected employees (McConnell, 2009). Though silent on mandatory versus voluntary tip pooling, the federal law is not silent on who may share in a lawfully established pool. As indicated above, only those employees who “customarily and regularly receive tips” can participate. Again, many state laws use different criteria for determining who is and is not eligible to receive tips from a tip pooling arrangement (McConnell, 2009). Other areas in which state laws differ from one another include those which address how tipped employees are notified that the employer is utilizing a tip credit system and whether “service fees” are treated as tips to be paid out to employees or simply additional revenue to be retained by the business.

Why Class Action Lawsuits?

At this point in time, class action lawsuits are the preferred method being used by the parties bringing these lawsuits over purportedly illegal tip pooling arrangements. In many respects, class action lawsuits are designed for precisely this kind of situation. A class action lawsuit is one in which a single individual or small group of individuals brings a lawsuit on behalf of a larger group all of whom allegedly suffered the same legal wrong. In many instances, the alleged violations involve small damages to any one plaintiff but are significant when added together for all group members. Consequently, permitting such cases to proceed on behalf of the larger group permits a wrong (if there is one) to be remedied when a single individual pursing such a claim would be impractical. For example, consider a hypothetical in which a wireless phone company systematically overcharges each of its customers by $1.00 per month. Even if they are aware of it, few customers possess access to the financial resources to mount a lawsuit for the purposes of recovering such a paltry amount. However, when that $1.00 per month overcharge is multiplied by the total number of customers over a period of years, it represents substantial revenue to the company. Such situations represent the classic type of scenario envisioned for class action lawsuits. Individual tipped employees are in a similar situation in that the damage to any single employee is small while the overall impact can be significant.

Federal law permits class actions in civil lawsuits under certain limited circumstances. For a lawsuit to proceed as a class action, it first must be certified by a judge as meeting the applicable criteria. That is, a judge has to approve a lawsuit as a class action lawsuit for it to proceed as such. The general rules laying out the criteria for class certification are found in Rule 23(a) of the Federal Rules of Civil Procedure:

In the Massachusetts class action lawsuit, the basic question before the court was whether Starbucks’ tip pooling policy violated applicable state law by permitting shift supervisors to share in the tip pool that, allegedly, should have been limited to baristas. Consequently, under Rule 23(a), the court certified as a class “[a]ll individuals who were employed as baristas at any Starbucks store located in the Commonwealth of Massachusetts at any time between March 25, 2005, and [March 18, 2011] inclusive” (Matamoros v. Starbucks Corp., 2012, p. 17). Similarly, the New York case against Starbucks involves which categories of employees are eligible to participate in the tip pool in light of New York’s tip pooling statute. However, the New York case raises the question not only in regard to baristas and shift supervisors but also assistant store managers. In New York what began as two separate cases was consolidated by the court into a single case because of the common questions raised in each (Barenboim v. Starbucks Corp. & Winans v. Starbucks Corp. 2012).

It is not hard to see how these cases readily lend themselves to meeting the criteria for class certification. They involve large numbers of people – all employees who hold certain job titles during the relevant period of time (Rule 23(a)(1)). The legal and factual questions are essentially the same – employees were subject to the same tip pooling policy and those holding certain titles shared in the tip pool while others did not (Rule 23(a)(2)). The claims and defenses of the named parties who brought the lawsuit are essentially the same as those of other members of the class – all employees holding the same job title were treated the same (Rule 23(a)(3)). And finally, the named parties are in a position to adequately represent the interests of other members of the class (Rule 23(a)(4)). Among other things, this last criteria is established by virtue of the parties showing they have access to the necessary and appropriate resources to adequately pursue the case. This turns in part on the lawyers who are representing the class. As noted by Maatman in the 2013 Edition of the Annual Workplace Class Action Litigation Report : “A certitude of the modern American workplace is that class action litigation … is a magnet that attracts skilled members of the plaintiff’s bar” (Maatman, 2013, p. 7). Indeed, some lawyers have developed a specialty in bringing class action tip related lawsuits. For example, Shannon Liss-Riordan and Hillary Schwab who are involved in both the Massachusetts and New York cases against Starbucks describe themselves as “pioneering … the law protecting tipped employees” touting “more than fifty court-approved class action settlements” for tip law violations (Lichten & Liss-Riorden, P.C.: The Labor, Employment & Class Action Specialists, 2011). It is worth noting that this is only two lawyers from one Boston law firm.

New Developments: Massachusetts Class Action Tip Pooling Ruling

The first Massachusetts case against Starbucks was filed in 2008 (Qualters, 2012). The lawsuit challenged Starbucks’ policy regarding which categories of employees are eligible to participate in the tip pool. The lawsuit alleged that in violation of Massachusetts state law, Starbucks’ corporate policy permitted ineligible employees to share in the tip pool. Specifically, the lawsuit claims that under Massachusetts law, the only Starbucks’ employees eligible to participate in a store’s tip pool are baristas. In resolving this question, as noted by Judge Selya in the court’s decision, this case “presents an unsettled question as to the meaning of the current version of the [Massachusetts] Tip Act” (Matamoros v. Starbucks Corp., 2012, p. 5) (emphasis added).

In 2004, the legislature amended the Massachusetts Tip Act and it is this new and amended version at issue in the lawsuit against Starbucks. The relevant portions of the amended statute in dispute include the following.

No employer or person shall cause, require or permit any wait staff employee service employee, or service bartender to participate in a tip pool through which such employee remits any wage, tip or service charge, or any portion thereof, for distribution to any person who is not a wait staff employee, service employee, or service bartender. An employer may administer a valid tip pool and may keep a record of the amounts received for bookkeeping or tax reporting purposes (Massachusetts Tip Act, §152A(c) 2013).

In short, this provision of the Massachusetts Tip Act allows employers to require employees to participate in a tip pooling arrangement. However, this is permitted only within certain limitations. One of those limitations is that “’wait staff’ employees shall not be required to share tips with anyone who is not a ‘wait staff employee’” (Matamoros v. Starbucks Corp., 2012, p. 6). The legal definition of “wait staff employees” is found in another section of the Massachusetts Tip Act.

The court’s decision in this case turned on its interpretation of which categories of Starbucks’ employees qualified as “wait staff” within the meaning of that term as defined by Massachusetts law.

As described by Judge Selya, Starbucks outlets operate with four categories of employees:  store managers, assistant managers, shift supervisors and baristas. The primary focus of this case involved baristas and shift supervisors. Per company policy, both categories of employees shared in the tip pool at each Massachusetts Starbucks store. Judge Selya noted that while both baristas and shift supervisors directly waited on customers; baristas were the “front- line employees” while “shift supervisors perform those functions and other functions as well” (Matamoros v. Starbucks Corp., 2012, p. 3). While it is easy to see that both baristas and shift supervisors meet the definition of “wait staff” in accordance with the first two criteria (they directly wait on customers in a business that serves food and beverages) of the Massachusetts Tip Act provisions, it is not clear whether the “other functions” performed by shift supervisors are managerial responsibilities that render them ineligible under the third criterion.

In defending the legality of including shift supervisors in their tip pooling policy, Starbucks pointed out that shift supervisors spend “up to ninety percent” of their time doing the same work as baristas (Matamoros v. Starbucks Corp., 2012, p. 7).  Further, while conceding that shift supervisors indeed perform “limited supervisory tasks,” Starbucks argued that these tasks are insufficient to qualify as “managerial responsibility” (Matamoros v. Starbucks Corp., 2012, p. 7).  In evaluating these claims, the court examined the nature of these additional tasks. As described by the court:

The court had little difficulty concluding that though limited in scope, these kinds of responsibilities nevertheless qualify as managerial in nature. Coupling this with the unambiguous language of the third criterion in the statute which defines wait staff as employees possessing “no managerial responsibility” (emphasis added), the court readily declared that “in this case, all roads lead to Rome;” in Massachusetts, Starbucks’ “shift supervisors are not ‘wait staff’ within the meaning of the Tips Act” (Matamoros v. Starbucks Corp., 2012, p. 16).

As a result of this ruling by the United States Court of Appeals for the First Circuit, the district court’s finding that Starbucks owed Massachusetts based baristas approximately $14 million (before interest) was upheld (Matamoros v. Starbucks Corp. 2013, p. 3).  Nevertheless, that is not the end of the case. This first Massachusetts case against Starbucks covered the period of time from March 25, 2005 to March 18, 2011 (Matamoros v. Starbucks Corp., 2012, p. 5). Consequently that $14 million does not address baristas who were illegally required to share tips with shift supervisors after March 2011. While the first case made its way through the courts, Starbucks continued to operate with a tip pooling policy permitting shift supervisors to share in the pool. To address the continuing improper tip pooling arrangement, the same lawyers who brought the first case, filed a second tip pooling case against Starbucks in Massachusetts – Black v. Starbucks Corp. (2012). At this point, both cases have been consolidated into a single class action settlement which calls for Starbucks to pay $23.5 million plus the costs of administration to settle both cases (Matamoros v. Starbucks Corp. 2013, p. 2).

New Developments: New York Class Action Tip Pooling Ruling

In New York, what began as two separate cases were consolidated into a single case for the purposes of proceeding to trial (Barenboim v. Starbucks Corp. & Winans v. Starbucks Corp.2012). The general question raised in New York is the same question raised in Massachusetts: which categories of employees are entitled to share in the tip pooling arrangement? Nevertheless, the specifics of the New York case are different in two respects. First, the applicable New York statute is different from that in Massachusetts. Second, the New York case not only raises the question of whether both baristas and shift supervisors are eligible to share in the tip pooling arrangement; it challenges Starbucks’ policy of excluding assistant store managers from participating in the tip pool.

Under New York law, the state law defining who is and is not eligible to share tips was adopted in 1968 and reads as follows:

The crux of this case revolves around the interpretation of which Starbucks’ employees are “agents” of the corporation. As spelled out in the statute, an “agent” of the employer is not eligible to share tips while a “busboy” or “similar employee” is eligible to participate in a tip pooling arrangement. In the portion of this case dealing with baristas and shift supervisors, the baristas argue “that any supervisory responsibility, however slight, renders an employee (such as a shift supervisor) an agent, and therefore, ineligible to participate in a tip pool” (Barenboim v. Starbucks Corp. & Winans v. Starbucks Corp. 2013, p. 8). On the other side of this argument are the assistant store managers who want to be included in the tip pool. They argue for their inclusion by “contending that only employees with ‘full’ managerial authority – i.e., the ability to hire and fire subordinates – should be viewed as agents and, as a result, assistant store managers remain eligible for tip distribution” (Barenboim v. Starbucks Corp. & Winans v. Starbucks Corp. 2013, p. 8). Starbucks takes a middle position.  In defense of its tip pooling policy, Starbucks argues that shift supervisors are sufficiently similar to waiters that they should be permitted to share in the tip pool while the “significant managerial” responsibilities of assistant store managers should render them ineligible as “agents” of the company (Barenboim v. Starbucks Corp. & Winans v. Starbucks Corp. 2013, p. 8).

To resolve the proper interpretation of the statutory language relative to the baristas, the court turned to guidance from the New York Department of Labor (DOL). In doing so, the court observed that “the DOL has consistently, and in our view, reasonably, maintained that employees who regularly provide direct service to patrons remain tip-pool eligible even if they exercise a limited degree of supervisory responsibility” (Barenboim v. Starbucks Corp. & Winans v. Starbucks Corp. 2013, p. 8). Consequently, the court concluded that shift supervisors are not “agents” of Starbucks and thereby are eligible to share in the tip pooling arrangement.

For the assistant store managers, the court had to determine whether (as the assistant store managers argued) only employees with the authority to hire and fire subordinates qualify as “agents” of the employer. In the end, the court rejected this proposed litmus test. As the court explained:

Having established the legally appropriate standard, the appeals court returned the question of whether assistant store managers possessed such “meaningful authority” to the trial court for it to determine.

This left one remaining question in this case. Does the applicable New York law require employers to include in their tip pooling arrangement all employees who are eligible to participate?  On this point, the New York Court of Appeals agreed with the lower court’s conclusion that while the New York law excludes some employees from being eligible for inclusion in a tip pooling arrangement, the language of the statue does not require the inclusion of all employees who meet the eligibility criteria (Barenboim v. Starbucks Corp. & Winans v. Starbucks Corp. 2013, p. 15).

Conclusion

In some ways, the most significant point to be drawn from all of this is that between 2006 and 2013, class action lawsuits over improper tip pooling shifted from being the “in vogue class action claim in California” (Jennings, 2006, p. 3) to a “key area to watch” according to the Annual Workplace Class Action Litigation Report  (Maatman, 2013, p.8).  Within the larger context, the Massachusetts and New York cases are simply part of what the Annual Workplace Class Action Litigation Report describes as a “deluge” of class action wage and hour lawsuits against corporations in the United States with “no end in sight” (Maatman, 2013, p.8).  This will continue to present a challenge to corporations whose employees receive part of their compensation in the form of tips – particularly when such employees are subject to an employer established tip pooling arrangement.

This leads to the second significant point. While violations of tip sharing requirements may be too small for any individual employee to pursue, when filed as class action lawsuits, seemingly small cases not only can but sometimes do turn into multi-million dollar losses.

Third, with the Massachusetts ruling, for the first time, Massachusetts businesses have a detailed interpretation from the courts concerning the meaning and application of the Massachusetts Tip Act. This important development coupled with the court’s endorsement of the unambiguous criteria to be applied forewarns businesses of the need to be particularly vigilant in complying with the law and remaining current with any changes. In all likelihood, more class action lawsuits over improper tip pooling will be brought against other Massachusetts corporations with tipped employees. It is difficult to imagine that Starbucks is the only larger employer in the state that failed to adjust its tip pooling policy when Massachusetts amended its state law in 2004.

Similarly, the New York case is significant in that it, for the first time, provided a court’s interpretation of certain aspects of New York’s tip sharing laws. In the New York cases, Starbucks prevailed by successfully defending the inclusion of shift supervisors in it tip pooling arrangement under the requirements of New York law. At the same time, the portion of that case involving assistant store managers remains to be resolved leaving ambiguity in that dimension of New York’s tip sharing law.

Finally, these case examples highlight the difficulty and complexity even a large corporation such as Starbucks encounters when complying with the myriad of both state and federal laws affecting its operations.  At the same time, it goes without saying that it is their very size and perceived resources (i.e. deep pockets) that makes them ready targets for the kind of lawsuits examined here.

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KEYWORDS: tip pooling, class action lawsuit, agent, managerial responsibilities, Fair Labor Standards Act

Originally published on Wednesday, 26 March 2014
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