Understanding the costs associated with tipping in cash

By Fourth|May 15, 2023|4:14 pm CDT

The history of tipping

Historically in the US, the front-of-house staff (specifically, servers, and bartenders) earns more in tips than they do in wages. This phenomenon is recognized by the U.S. Department of Labor, which allows directly tipped staff to be paid as little as $2.13 an hour on the expectation that they earn more than minimum wage in tips.

Before the ubiquitous use of credit and debit cards, tips were typically given directly by the customers to the staff in cash. Employees then either pocketed or shared them— depending on the practice at their workplace. The only involvement the employer had in these transactions was trying to persuade their employees to admit how much they were receiving so that it could be taxed.

However, the increased use of credit and debit cards means that diners have become used to adding tips directly to the check and paying the entirety of the bill as one charge.

In fact, 75% of consumers prefer to pay with a credit or debit card over cash when dining at restaurants.[1]

Although employees still receive cash tips they are usually for a small amount and the bulk of an employee’s tips are card tips that are collected for them by their employer. This means that the restaurant has unwittingly become an intermediary between the tipper and the tippee, having to pay out tips to the employee that they have collected on their behalf, often before the restaurant receives the funds themselves from credit card companies.

How do employees get their tips?

So how do employees get their tips? The easy answer is from their employer. So, the question then becomes: how does the employer get the tips?

Presuming the customers are paying with credit or with debit cards, then the card processor will pay directly to the restaurant’s bank account. Naturally, this will be several days later and most often at a fee of 2-3%. So, when a generous card-using diner adds a $100 tip on top of the bill, not only does the server not get that tip immediately, but the employer doesn’t get it reimbursed to them until a few days later—and when they finally do it might only be $97.

In the old days, the tipped staff would clock out at the end of their shift and head home clutching their tips in a day’s work. As card usage became more prevalent, and hat usage less so, the restaurant manager would make up the tips at the end of the shift by looking to see what card tips were recorded in the POS, opening the cash register, and counting out the money to hand over to each staff member. This process is commonly referred to as ‘tip cashing out’ but it is not ‘cash tips’ that are being paid out, instead it’s ‘card tips’.

So, whereas tips used to be a direct exchange between the customer and their server, the entire burden of managing and paying tips now falls on the business.

The cash conundrum

Cash itself is a big problem for many establishments. Cashing out tips became common when some customers started paying by card, but there was always cash in the register from the other customers who paid the old-fashioned way. But now that most customers pay by card, there is simply not enough cash naturally lying about in the restaurant, so instead, businesses are getting cash from the bank or having it delivered – just so they can cash out tips.

Some employers are paying to have cash delivered to their premises just so that they can hand it to their employees who will then deposit it in an ATM on the way home

When you peer underneath the initial response to payrolling tips it seems that what low paid staff living on a tight budget actually need is access to funds between pay days. The same need is fulfilled by earned wage access, which enables employees to draw down a portion of their earnings when and how they need, but this is often seen as a step too far by employers who are wed to the ‘all the money, everyday’ mantra. In practice we see that when given the flexibility of EWA, the amount drawn by all staff is only about a fifth of what was being cashed out to tipped staff.

The solution: digitizing the tip pay out process

Tip Pay Out is basically electronic tip cashing out: paying the employee their tips daily, but directly to an account or card rather than in cash. There are variations in how this is done, but the common theme is the elimination of actual cash.

Benefits of digital tip pay outs

Key benefits to adopting a digital tip pay out process mostly center around cost; specifically, the removal of the costs associated with cash collection for delivery, insurance, and manager time (labor). Managers no longer need to spend time cashing out at the end of the night or when individual shifts end, which means no more working out tips, counting tips, or distributing tips. And by eliminating the need for excess cash in stores, employers can also eliminate security costs and reduce the chances of theft or fraud. There is also the safety aspect: tales of staff being mugged for their tips on their way home in the late hours are not uncommon.

Another practical benefit is that the employees don’t need to receive the tips in person, so employees no longer have to wait around at the end of a shift to get paid out or wait until the next workday to collect their hard-earned tips. Besides, in this day and age, it is unlikely that they pay their rent or utility bills in cash, or daily, so they are having to go to a deposit point or ATM.

Did you know?

On average, it takes three days for payment networks like Visa to settle card payments and reimburse a business that pays out tips in cash the night that they’re earned by employees, seriously affecting a business’ cash flow process.

There are, of course, other benefits of having an automated, electronic version of distributing tips beyond not having to handle cash. The most significant benefit is that it’s easier to not pay out all tips, all at once. This may not immediately appear as beneficial but there are risks associated with paying out everything, every day, that can affect both employer and employee. The reasoning: all tips need to be taxed, and while reporting of cash tips is sometimes a little lackluster, the failure to accurately report card tips can get a company into trouble. It’s relatively common for employees to be taking home more in cashed-out tips than they should be receiving in net pay, particularly when an employee has a large value of deductions or garnishments, or sometimes just because they are paid the tipped minimum of $2.13 an hour.

For example, an employee earning $200 in tips for an eight-hour shift would be getting a total of $217.04, and after tax, benefits, and other deductions, their net pay will be less than $200—meaning they will owe some of that back to somebody.

The tip pay out process involves providing a report to payroll at the end of the period to say what has been paid and what is still owed so both can be processed. This makes it much easier to pay out, say, 85% of tips and leave the balance to be paid on the paycheck once all  deductions have been taken.

Add this as a call out by this section (not to be included in this article otherwise). Something like a “did you know?”

Moving forward with tip pay out

As with almost anything involving employees, the most important thing is good communication of a proposition that includes choice and flexibility. Despite all that is written above about how employees should react positively, the imposition of a rigid change may be met with suspicion. But the benefits of adopting tip pay out are clear, both for employer and employee, and the gradual societal abandonment of cash is making this new benefit essential to stay ahead of the curve in a competitive labor market.

When you’re ready to discuss adopting tip pay out, we’re here to help. Fuego by Fourth’s new tip pay out solution reduces an employer’s dependency on cash by automating the tip pay out process and providing employees with flexibility and choice in payment.

There’s no implementation fee for the employer, no subscription fee, and employers can choose if/when they want to pay the cost to transfer tips on behalf of the employee, even if just for the short term.

Learn how Fuego can help workers meet their financial goals and help employers develop a more optimistic, more engaged, and more productive workforce.

[1] Fiserv, Expectations & Experiences: Cards, Credit and Consumer Control survey, 2022

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