By Heidi Macomber · August 15, 2026

Tip Credit by State: The Restaurant Owner's Guide to Tipped Wages, Taxes, and the Real Math

Two numbers run the tipped restaurant economy in America: $2.13 and $7.25.

Federal law lets a restaurant pay a server a cash wage of $2.13 an hour, as long as the customer's tips lift that server to the federal minimum wage of $7.25 an hour. When tips are flowing, the customer is paying most of the wage and the owner is paying the payroll taxes that ride on top of it.

This guide lays out the state map, the compliance rules, the taxes the employer still owes on tip-funded pay, and the full math on a worked example. Just the numbers. What is fair is your call.

How the Federal Tip Credit Works

The rule lives in Section 3(m) of the Fair Labor Standards Act. It was created in 1966, the $2.13 cash wage was set in 1991, and Congress froze it there in 1996. The federal minimum kept rising to $7.25 in 2009, and the gap between the two became the maximum tip credit an employer can claim: $5.12 an hour.

Three conditions have to hold:

1. The employee must be a tipped employee who customarily and regularly receives more than $30 a month in tips.
2. The employee must be told the tip credit is being taken (many states require written notice).
3. If tips plus the cash wage do not reach the full minimum wage in a workweek, the employer must make up the difference out of its own pocket. This is called the make-up obligation. In plain terms: any workweek the dining room goes slow, whether that is bad weather, a dead season, or empty weeknights, you still owe enough cash wages to bring every tipped employee up to the full minimum wage. The customer's tips do not excuse you from that guarantee.

One more rule that matters: since a 2018 federal law change, tips belong to the employee. Managers and supervisors can never keep any portion of them, in any state, in any configuration.

The State Map: Three Groups

The federal numbers are only the floor. States split into three broad groups.

Group 1: No tip credit at all. Seven states do not allow a tip credit: Alaska, California, Minnesota, Montana, Nevada, Oregon, and Washington. Servers in those states must receive the full state minimum wage in cash from the employer, and tips go on top of it. These are not small numbers: the July 2026 DOL table shows Washington at $17.13 an hour, California at $16.90, and Oregon ranging from $14.55 to $16.80 by region. If you operate in these states, the customer tip model of labor funding does not exist for you.

Group 2: Higher cash wage than federal. A large middle group sets its own tipped cash wage above $2.13 but below the full state minimum. New York, for example, sets regional tiers ($17.00 combined minimum in New York City, Long Island, and Westchester; $16.00 in the rest of the state, with the cash-wage split varying by employer type). Michigan's cash wage is $5.49 against a $13.73 minimum, and it is scheduled to rise each year until it reaches 50 percent of the state minimum in 2031. The exact dollar amounts in this group change whenever a state legislature updates them. Washington D.C. is phasing its tip credit out under a 2022 voter initiative: as of the July 2026 DOL table it requires a $10.30 cash wage against an $18.40 minimum, with the required cash share increasing each year.

Group 3: The federal $2.13. More than a dozen states, concentrated in the South and Great Plains, follow the federal pattern exactly: $2.13 cash wage, $7.25 combined minimum. Alabama, Louisiana, Mississippi, Tennessee, and Texas are in this group, along with their neighbors.

One wrinkle worth knowing: two states keep the $2.13 cash wage but set the combined minimum much higher. Virginia requires tips to fill $10.64 an hour (combined minimum $12.77) and Nebraska requires $12.87 (combined minimum $15.00). Same $2.13 cash wage as Alabama, more than double the gap the tips must cover. The lesson: never budget off the cash wage alone. The number that matters is your state's combined minimum, because that is what you guarantee under the make-up rule.

The authoritative, updated table is the Department of Labor's state tipped minimum wage page (last revised July 1, 2026, when this article was checked against it). It changes often enough that you should still check it for your state rather than trust any article, including this one:

https://www.dol.gov/agencies/whd/state/minimum-wage/tipped

Take the Credit or Not: What Each Choice Actually Means

Before the numbers, here is the choice in plain terms.

If you take the tip credit:

• Out of your pocket, you pay the tipped cash wage: $2.13 an hour in federal-tier states.
• Customer tips count as part of the server's wages. They fill the gap between $2.13 and $7.25.
• If tips fall short in any workweek, you pay the difference yourself.
• Your tip pool can include only tipped roles: servers, bussers, bartenders, runners.
• On overtime, tips can still cover part of the rate (spelled out below).

If you do not take the tip credit:

• Out of your pocket, you pay the full minimum wage in cash: $7.25 federally, or your state's full minimum where it is higher.
• Tips no longer count as wages. Every tip belongs to the server on top of the paycheck.
• There is no make-up situation to track, because you already pay the full minimum every week.
• You may include back-of-house cooks and dishwashers in the tip pool.

Same server, same customers, same tips on the table. The choice decides who funds the gap between $2.13 and the minimum: the customer's tip, or your bank account.

The Owner Math: A Worked Example

Assume you operate in a $2.13 state. You have one full-time server, 40 hours a week, averaging $12 an hour in tips. Combined with the cash wage, that puts the server's all-in earnings near the middle of what the Bureau of Labor Statistics reports for servers overall, so it is a fair test case.

Scenario A: You take the tip credit.

The server earns $14.13 an hour all-in, above the $7.25 requirement, so no make-up is owed. Your cash wage cost for the week is $85.20. The customer funded $480 of the server's $565.20 in total weekly pay.

Scenario B: Same server, no tip credit.

Same server, same week, same $480 in tips. The difference is $204.80 a week, which is $10,649.60 a year, per server. A dining room running eight servers on the tip credit instead of the full minimum carries roughly $85,000 a year less in direct wage cost. That single line explains why the policy fight is so intense.

The Make-Up Week: What Happens When Tips Fall Short

Now assume a brutal week. A snowstorm, a slow season, a road closure. The same server averages $2.50 an hour in tips.

$2.13 cash wage + $2.50 tips = $4.63 an hour. That is below the $7.25 minimum, so the make-up rule activates. You owe enough cash wages to guarantee $7.25:

$7.25 − $2.50 in tips = $4.75 an hour in cash wages. Over 40 hours, that is $190.00 for the week instead of $85.20.

The tip credit lowers your labor cost only when tips actually flow. When they stop, the full minimum wage is still yours to fund. Owners who get hurt are the ones who annualized the $85.20 week and forgot the $190 week exists.

The Taxes: What You Owe When the Customer Pays the Wage

This is the part most guides skip. Even when customers fund most of the hourly rate, the employer owes taxes on the full picture.

FICA (Social Security and Medicare), 7.65%. Reported tips are taxable wages under FICA, and the employer match applies to them whether or not you take a tip credit. On the worked example: $85.20 in cash wages + $480 in tips = $565.20 of FICA wages. Your match is 7.65% × $565.20 = $43.24 for the week.

The Section 45B credit. Here is the cushion Congress built in. Under Section 45B of the Internal Revenue Code, a food or beverage establishment can claim a business tax credit for the employer FICA paid on tips above the amount needed to bring an employee to minimum wage. On the worked example: tips needed to reach the minimum are $5.12 × 40 = $204.80. Tips above that are $480 − $204.80 = $275.20. The FICA on that excess, $275.20 × 7.65% = $21.05, comes back to you as a general business credit. Of the $43.24 weekly FICA bill, roughly $21.05 is recoverable at tax time. Your tax software or CPA handles this, but you should know it exists, because it meaningfully softens the FICA cost of tips.

Federal unemployment (FUTA). Tips are excluded from FUTA wages. FUTA applies to cash wages only, on the first $7,000 per employee per year, at a net rate of 0.6% in most states (a handful of states pay more under credit reductions). On the worked example that is about $0.51 a week versus $1.74 if you paid the full minimum in cash. Small, but it moves with your cash wage, so the tip credit lowers this too.

State unemployment (SUTA). This varies by state. Some states exclude tips from the wage base, some include reported tips, and rates depend on your experience rating. Check your own state's rules before budgeting.

Workers' compensation. In many states, workers' comp premiums are calculated on payroll including reported tips, because that is the real income being insured. A server earning $14 an hour all-in costs more to insure than one earning $2.13 in cash wages. Ask your carrier how they treat tips, because it changes the premium.

The bottom line: the tip credit saves you the $5.12 an hour in wages, while most of the tax obligations ride along on the tips either way, and Section 45B lets you recover the FICA on the tip portion above minimum wage.

The Overtime Trap

This is the single most common tip-credit violation, and it is expensive. The rule: the overtime rate must be built on the full minimum wage, never on $2.13. Here is the arithmetic one step at a time, using the federal numbers.

Step 1. Build the overtime rate on the full minimum wage. Federal overtime is 1.5 × the full minimum: 1.5 × $7.25 = $10.88 an hour. That $10.88 is the total the server must receive for every overtime hour, from cash wages and tips combined.

Step 2. If you take the tip credit, subtract it once. You are allowed to count tips toward that $10.88, exactly like straight time. The maximum tip credit does not grow on overtime; it stays $5.12 an hour. So the cash you pay is $10.88 − $5.12 = $5.76 per overtime hour, and the tips the server earns that hour cover the other $5.12. If the tips do not actually cover it, you pay more cash.

Step 3. If you do not take the tip credit, subtract nothing. You simply pay the whole $10.88 in cash for every overtime hour, and the server keeps their tips on top.

The violation looks like this: an owner multiplies the cash wage instead, 1.5 × $2.13 = $3.20 an hour, and pays that. But the server was owed $10.88 an hour all-in, so the shortfall is $7.68 on every single overtime hour. Multiply that across a whole staff over multiple years and you get the back-pay cases. The Department of Labor's Fact Sheet #15 covers this in plain language:

https://www.dol.gov/agencies/whd/fact-sheets/15-flsa-tipped-employees

Tip Pools: The 2020 Rule

Under the Department of Labor's 2020 tip regulations, the rules split on whether you take a tip credit:

• If you take the tip credit, your tip pool can only include employees who customarily receive tips: servers, bussers, bartenders, runners.
• If you pay everyone the full minimum wage and take no tip credit, you may include back-of-house cooks and dishwashers in the pool.

Managers and supervisors can never share in tips under either setup.

This creates a real strategic choice. Operators who drop the tip credit gain the option of pooling the whole house to lift kitchen pay, and several big names tried exactly that.

How the Big Chains Handle It

Searching the SEC's EDGAR full-text database for the phrase "tip credit" returns hundreds of 10-K filings from restaurant companies. You can run the same search yourself: go to https://www.sec.gov/edgar/search/ and enter "tip credit" with the form filter set to 10-K.

The more interesting data is what happened when well-funded companies tried to leave the tip system voluntarily:

• Union Square Hospitality Group (Danny Meyer's group, Union Square Cafe, Gramercy Tavern) eliminated tipping at its restaurants starting in late 2015 under a program called Hospitality Included, raising menu prices to fund kitchen and service pay. The company walked most of it back starting in 2020, returning to tipping at the majority of its restaurants.
• Joe's Crab Shack tested no-tipping at 18 locations in 2015, one of the largest casual-dining experiments. It reversed course within about a year after traffic and staffing problems, and the parent company ended up in bankruptcy in 2017.
• Shake Shack removed tipping chain-wide in 2016 in favor of hospitality included, then reintroduced tipping in 2019 after guest feedback.

The pattern in the data: when a restaurant replaces customer tips with wages, menu prices have to rise by double-digit percentages to fund it. Traffic drops, or the best servers leave for competitors where they can earn $25 an hour in tips, or both. Nearly every large operator that tried it at scale went back. Meanwhile, the major casual-dining chains continue to take the tip credit everywhere state law allows, and disclose the exposure in their filings.

For a small operator, the takeaway is not that tips are good or bad. It is that the model you choose determines who funds your labor line: the customer directly through tips, or the customer indirectly through the menu prices you would need to charge instead.

Planning Checklist for Small Operators

1. Confirm your state's current tipped cash wage on the DOL table before you build any labor budget. It is the single most state-dependent number in your P&L.
2. Track tips by shift and by workweek, not by pay period, so you catch make-up situations in the week they happen.
3. Set your overtime pay rules on the full minimum wage, never on the tipped cash wage.
4. Decide your tip pool structure knowing the trade: keep the tip credit and pool only tipped roles, or drop it and open the pool to the whole house.
5. Make sure Section 45B is on your CPA's checklist at tax time. It recovers employer FICA on tips above the minimum wage need.
6. Watch your state's legislature. Michigan and Washington D.C. are mid-transition, and several other states have active campaigns on both sides of the issue.

Sources

• Department of Labor, state tipped minimum wage table, last revised July 1, 2026: https://www.dol.gov/agencies/whd/state/minimum-wage/tipped
• DOL Fact Sheet #15, tipped employees under the FLSA: https://www.dol.gov/agencies/whd/fact-sheets/15-flsa-tipped-employees
• Fair Labor Standards Act, tip credit definition, 29 U.S.C. § 203(m): https://www.law.cornell.edu/uscode/text/29/203
• Internal Revenue Code § 45B, credit for FICA paid on certain tips: https://www.law.cornell.edu/uscode/text/26/45B
• IRS Publication 15, tip wage withholding and reporting rules: https://www.irs.gov/publications/p15
• SEC EDGAR full-text search, "tip credit" in 10-K filings: https://www.sec.gov/edgar/search/

Related Guides

• Restaurant Labor Cost: The Full Guide Beyond Just Scheduling — Fully loaded labor cost, overtime math, and budgets that flex with sales
• How to Calculate Labor Cost Percentage — The baseline labor metric this article builds on
• Restaurant Prime Cost Explained — Where tipped wages land in your total cost of food plus labor
• Restaurant Cost Percentages Guide — Benchmark ranges for every line of your P&L

View this article in the app: https://percyplate.com/blog/tip-credit-laws-by-state-restaurant-owner-math