Rock the 2025 FPC Exam – Master Payroll Fundamentals with Confidence!

A tip credit refers to the provision that allows employers to pay a lower minimum wage to employees who earn tips. This is because the total earnings of tipped employees—when combining their base wages and tips received—are expected to meet or exceed the federal or state minimum wage.

According to the Fair Labor Standards Act (FLSA), employers who qualify for the tip credit can pay eligible tipped employees a lower cash wage, which is usually set significantly below the federal minimum wage. In exchange, employers offset this lower wage by counting the tips received by the employees toward the minimum wage threshold.

For instance, if the minimum wage is $7.25 per hour and an employer can utilize a tip credit of $3.00 per hour, the employer would pay the employee a base wage of $4.25 per hour. As long as the employee's tips combined with the base wage equal at least $7.25 per hour, the employer complies with wage laws.

This concept plays a key role in the payroll process for businesses that employ individuals in tipped positions, such as servers, bartenders, and valets, allowing them to maintain compliant payroll while still providing a fair total compensation for the employees.