How does a tip credit affect minimum wage?

• A. Tip credits reduce federal income tax
• B. Tip credit toward minimum wage for tipped employees
• C. Tips are not considered wages
• D. Tips are included in wages and subject to payroll taxes

Answer: (B)

Tipped employees can be paid a lower cash wage because tips are counted toward meeting the minimum wage obligation through a tip credit. In other words, the employer uses a tip credit to reduce the direct cash wage, as long as the combination of the cash wage plus the employee’s tips equals at least the applicable minimum wage. For example, if the federal minimum wage is $7.25 and the allowed tip credit is $5.12, the employer can pay $2.13 in cash per hour, with tips counting up to $5.12 toward the minimum. If tips don’t reach the required total, the employer must make up the difference with cash wages. Tips themselves are wages for tax purposes, but the question focusing on minimum wage is about how the tip credit works to satisfy that wage requirement.