Is It Legal for Employers to Deduct Credit Card Processing Fees from Tips?

In general, yes, it’s legal, except where prohibited by state or local laws.

States that currently prohibit processing fee deductions from tips are California, Maine, and Massachusetts. According to Nolo.com, the law is not clear in three additional states: Delaware, Kentucky, and Montana.

In each of those states, existing laws regarding tips don’t specifically address credit card processing fee deductions, but do include stipulations that gratuities belong to the employee. It’s unclear if courts would rule in a business’ or employee’s favor in those specific states. If you plan to deduct processing fees from your servers’ tips, consult a licensed employment attorney in your area for guidance.

• Rules for Deducting Credit Card Fees from Gratuities
• Calculating the Deduction
• State Laws for Deducting Fees from Tips
• Alternatives to Tip Deductions

Rules for Deducting Credit Card Fees from Gratuities

In states where processing fee deduction from gratuities is allowed, there are still rules you’ll have to follow:

An employer can deduct the cost of processing the gratuity portion of the bill from the server’s tip.
An employer cannot deduct the cost of processing the entire bill from the server’s tip.

This is clearly stated in the Department of Labor’s website in a section concerning tipped employees under the Fair Labor Standards Act (FLSA.) The relevant section states:

“Where tips are charged on a credit card and the employer must pay the credit card company a percentage on each sale, the employer may pay the employee the tip, less that percentage.”

This sets the circumstances in which an employer can deduct processing fees from an employee’s tips. If the tip is paid by credit card and the employer pays a processing company a percentage of the transaction to process the sale, the employer can deduct the processing percentage from the employee’s tip, for the amount paid to process the tip.

The DOL website clarifies:

“For example, where a credit card company charges an employer 3 percent on all sales charged to its credit service, the employer may pay the tipped employee 97 percent of the tips without violating the FLSA.”

It’s often incorrectly suggested in online forums and discussion groups that the employer can deduct the entire processing fee. However, the example given by the DOL clearly illustrates that only the amount it costs to process the tip can be deducted from the tip, as it states that the tipped employee would receive 97% of the tip if the restaurant has to pay 3% to the processing company per transaction.

Here’s what an example looks like with numbers.

If a customer leaves a $1.00 tip on a $10.00 check using a credit card and it costs the restaurant 3% to process the transaction, the total cost to process that transaction is $0.33. (11 x 0.03 = 0.33.) Of that total, the cost to process the employee’s tip is 3 cents. (1 x 0.03 = 0.03.)

At a 3% processing rate for credit card transactions, the employer would need to give 97% of the tip to the employee, per the FLSA. The employer could deduct 3 cents from the employee’s tip, giving the employee $0.97.

If the employer deducted the full cost of the transaction, $0.33, they would only give the employee $0.67, which works out to 67% of the tip. This would not be acceptable per the FLSA regulation.

The Department of Labor’s website further specifies that employer may only deduct a processing fee if the employee’s pay will still be at or above minimum wage. Additionally, the tip must be paid to the employee in a timely manner. The exact wording is:

“This charge on the tip may not reduce the employee’s wage below the required minimum wage. The amount due the employee must be paid no later than the regular pay day and may not be held while the employer is awaiting reimbursement from the credit card company.”

If you intend to deduct processing fees from servers’ tips, be sure to adhere to all portions of the FLSA and any applicable state or local laws.

Calculating the Deduction

Another factor when taking processing fees from gratuities is the complexity of pricing. Credit card processors often charge restaurants a percentage that can vary depending on everything from the type of card used to the way it’s entered into the restaurant’s POS system.

Bloomberg’s Bureau of National Affairs cites specific cases where courts have maintained that employers are not violating FLSA standards if “the employer shows by a preponderance of the evidence that ‘in the aggregate, the amounts collected from its employees, over a definable time period, have reasonably reimbursed it for no more than its total expenditures associated with credit card tip collections.’” In another case, the court held that a restaurant may deduct an amount no greater than the actual amount of the processing fee.

This indicates that courts have traditionally ruled favorably to businesses as long as the restaurant was not charging more than the costs to process the tips overall.

In this situation, it’s best to err on the side of caution. You’ll need to know what your typical credit card processing fees are before deciding the deduction from servers’ tips. It may be a good idea to deduct a bit less than your costs, just to be on the safe side.

Related Article: How to Read Your Credit Card Processing Statement.

State Laws for Deducting Fees from Tips

In the majority of states, there are no laws that expressly prohibit or expressly permit deduction of credit card processing fees from an employee’s tips. The rest of the states either expressly prohibit the deduction, expressly allow the deduction, or have laws that refer to tips generally but not to the deduction and so are considered somewhat unclear on the subject.

The map above shows states’ rules regarding tip deductions. Below is more information for those states that have laws or in which the laws aren’t clear.

Expressly Prohibited or Unclear

The following states expressly prohibit deducting fees from tips, or have laws that are considered unclear on the subject accordingly to Nolo.com.

California: Prohibited.
According to California state law, employers must give employees the entire tip from the customer. Employers are responsible for paying the entirety of the credit card processing fee.

Colorado: Not prohibited, but subject to rules.
Colorado rules are a little more complex. Employers may be required to publicly post a notice when keeping any portion of an employee’s tip. Furthermore, if you deduct processing fees from tips, you may not be able to claim the employee tip credit. If you’d like to deduct fees from tips in Colorado, it’s strongly suggested that you consult a licensed attorney.

Delaware: Unclear.
Delaware’s law states that tips are the sole property of the employee (except in valid tip pools) but does not specifically refer to credit card processing fee deductions. It’s unclear if employers are allowed to take a deduction for processing fees, and Delaware courts have not ruled on such cases.

Kentucky: Unclear.
Like Delaware, laws in Kentucky don’t directly reference credit card processing fee deductions from tips. What Kentucky law does specify is that employers are prohibited from taking tips unless they are required to do so by state or federal law. It’s unclear whether that statement applies to processing fees.

Maine: Prohibited.
Maine law is generally interpreted as prohibiting processing fee deductions from gratuities. The law says that credit card tips will be treated like tips given directly to an employee, which Nolo suggests prohibits employers from deducting fees from the employee’s tip.

Massachusetts: Prohibited.
Massachusetts has two laws that apply to gratuities. One states that “tips” expressly includes gratuities added to the bill by the customer and paid with a credit card. The second prohibits employers from taking deductions from employees’ tips except for valid tip pools. These laws together prohibit employers from deducting fees from gratuities paid by credit card.

Montana: Unclear.
Montana law does not address the issue of processing fees directly, although it does say that all tips, including those left by credit card, belong to employees.

Expressly Permitted

Deducting credit card processing fees is expressly permitted by law in the following states:

• Minnesota
• New York
• North Carolina
• Utah
• Vermont

FLSA rules regarding fee deduction still apply. Additionally, it’s considered good practice to advise employees in advance. Some Departments of Labor, like the Vermont DOL, suggest providing written documentation of the policy in the employee handbook or a written memo.

Alternatives to Tip Deductions

If you’re in a state that prohibits tip deductions, or if that’s just not the route you want to take with your employees, your best bet is to make sure you’re not overpaying for credit card processing in the first place. Unfortunately, many restaurants and businesses with tipped employees are overpaying.

Grab your credit card processing statement and take 2 minutes to compare your current pricing to options available for restaurants. Plug in your business info using CardFellow’s free quote comparison tool to see the rates and fees you could be paying. It’s free, private (no sales calls!), and there’s no obligation. Try it here.

Securing credit card processing with lower total costs can help your bottom line while avoiding unhappy employees.

Related Article: Tablet POS Systems for Higher Restaurant Turnover.

Information contained in this article is provided for reference purposes only and does not constitute legal advice. Always consult a licensed attorney for legal advice.