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Life is filled with risky decisions. Should you take that new job? Should you put in an offer on that house that is just out of your price range? Should you really eat that last piece of cake when you’ve already had two? Companies make big gambles, too. For example, should Lionsgate really invest millions in a sequel to Now You See Me when nary a soul is clamoring for one?

In the wage and hour world, there are few risks more hazardous than the tip credit system. For the unfamiliar, the basic rule is that tips belong to employees, not the employer. Under the Fair Labor Standards Act (“FLSA”), employers may pay tipped employees less than the minimum wage, as long as the employees receive enough in tips to make up the difference. Easy, right? As the saying goes when cooking pasta: Step 1 – Measure the amount of pasta you need; Step 2 – Wrong.

The tip credit system is fraught with potential problems for employers. For example, if an employee does not receive sufficient tips to make up the difference between his direct wage and minimum wage, the employer must make up the difference. Or, when a tipped employee is required to contribute her tips to a tip pool that includes individuals who do not customarily receive tips, the employee is owed all the tips she submitted to the pool and the full minimum wage.

The Fifth Circuit Court of Appeals recently affirmed another potential pitfall for employers using the tip credit system. In <a href="https://employmentclassactionreport.bakerhostetlerblogs.com/wp-content/uploads/sites/8/2016/06/15-20139-cv0.pdf">Steele v. Leasing Enterprises, Ltd</a>., Case No. 15-20139 (5th Cir. 2016), the Perry’s restaurant chain in Texas paid its servers who received tips from customers $2.13 per hour in base pay, in accordance with 29 U.S.C. § 203(m) and C.F.R. §§ 531.52, 531.59. When customers paid and tipped with a credit card, however, Perry’s retained 3.25 percent of the tip to offset the credit card issuer fee and other costs incurred in collecting and distributing tips. The practice was not unusual; credit card companies typically charge businesses for the privilege of allowing customers to use cards to pay for products or food. The 3.25 percent retained by Perry’s was an attempt to offset the cost of that fee.

Unfortunately for the restaurant chain, however, the offset always exceeded the direct costs required to convert credit card tips to cash. The district court conditionally certified a class of servers that spanned over three years, from 2007 through October of 2010. The lower court later certified a second class of tipped employees from December 2010 through January of 2013.

In the bench trial, Perry’s conceded that its 3.25 percent offset always exceeded the total credit card issuer fees, including swipe fees, chargebacks, void fees and manual-entry fees. The restaurant argued, however, that the combination of fees and the cash-delivery expenses justified the offset. In other words, the restaurant claimed that it made a “business decision” to receive cash deliveries of wages three times a week in order to cash out servers’ tips each day and decrease the security concerns associated with keeping that much cash on hand. The district court and the Fifth Circuit were not convinced. Simply put, “Perry’s has not pointed to any additional expenses that are the direct and unavoidable consequence of accepting credit card tips,” and because the offset “always exceeded the direct costs required to convert credit card tips to cash,” the court held that the 3.25 percent offset violated section 203(m) of the FLSA. The punishment for such a penalty is severe, and Perry’s “must be divested of its statutory tip credit for the relevant time period.”

If there is a silver lining for the defendant, however, it is the fact that the Fifth Circuit did not find a willful violation of the FLSA. It did, however, award the plaintiff class their attorneys’ fees.

The Bottom Line: Like reaching for that extra piece of cake, the tip credit system is alluring but dangerous. Employers cannot take shortcuts or offset their obligations – the results can be sweeping and expensive.

Here’s a Tip for You, Jack – Fifth Circuit Upholds Ruling on Restaurant Credit Card Offset