Beware: Payroll Companies May Mishandle Garnishments of Tipped Employees

By Chrys Martin, Davis Wright Tremaine

Garnishment is a legal process by which an employer must withhold funds in its possession belonging to an employee and send them to a creditor. However, some direct tips are never in the employer’s possession, and accordingly are not likely subject to garnishment.

Tips cannot be garnished or calculated as part of earnings for garnishment purposes unless the employer has had control over those tips (e.g., tip sharing, service charges etc.). Many employers are not aware of this restriction and erroneously include tips in calculating earnings when processing garnishment orders. Unfortunately, many payroll vendors also are not aware of the intricacies of the law, and their garnishment systems are not set up to factor in the “tip” issue properly. State and federal laws also may vary on calculations of earnings depending upon the type of garnishment.

Under the Consumer Credit Protection Act (CCPA), only certain types of income can be garnished. Generally tips are not considered income for such purposes. Notably, tips paid directly to an employee by a customer and tips charged to credit cards that briefly pass through the employer before remittance to the employee are excludable from garnishment.

A directive in the DOL Handbook dated Feb. 9, 2001, eliminates doubt that a gratuity paid directly to an employee is not considered earnings. Chapter 16 of the DOL Handbook specifically describes the applicability of the CCPA to tips and gratuities. It states:

  • Bona fide tips are not subject to the provisions of the CCPA. A garnishment is inherently a procedural device designed to reach and sequester earnings held by the garnishee (usually the employer). Tips paid directly to an employee by a customer are not "earnings" within the meaning of [15 U.S.C.A.  1672] the CCPA, since they do not pass to the employer. This includes gratuities transferred free and clear to an employee at the direction of credit customers who add tips to the bill.

  • Service charges added to a customer's bill constitute "earnings" within the meaning of [15 U.S.C.A. 1672] when passed on to the employee. As such, they are subject to the provisions of the CCPA. The following examples demonstrate the point.

    • A restaurant charges a customer 15% of the check, as a service charge, and in turn pays this amount to the server (debtor). Since this is an automatic charge, there is no gratuity by the customer. The compensation passed from the employer (garnishee) to the server.

    • The employment agreement is such that the customer's tips belong to the employer and must be credited or turned over to the employer.(i.e., shared tips or pooled tips that go the employer and are then later turned back over to the employee less some sharing, processing fee, etc.)

Even some nationally recognized payroll processing services aren’t aware of these distinctions. Most restaurant employers aren’t either. Employers should verify with their payroll processing companies or their internal payroll staff that tips are being allocated correctly in garnishment processing.
 

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