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Understanding Minimum Wage Calculations

A friendly, smiling waiter is chatting with three women patrons who're sitting at their table looking up at him, probably listening to him telling them about the specials of the day. The restaurant has a dark ambience, with a single light hovering over each table. The waiter is likely paid a special tipped worker's wage, which is slightly more difficult to calculate and is one reason business owners should understand minimum wage calculations.

Supply and demand. It’s basic capitalism. And this concept applies to the labor market too. As a business, when you need help but there aren’t a lot of applicants, you raise wages to get or keep your workers. You typically pay a lot more than the minimum wage. But if lots of people apply, you might be able to pay closer to the minimum wage and still be able to hire the help you need. So, as a small business, you need to understand minimum wage calculations so you can adjust your wages based on the labor market.  

The US has had a minimum wage law since 1938 through the Fair Labor Standards Act (FLSA). (There were earlier attempts that didn’t stick.) We quickly went over the basic minimum wage rules in our big intro article on how to hire your first employees. In this article, we’ll take a more detailed look at the default minimum wage law as well as local and job-specific exceptions to the minimum wage.

As a reminder, the FLSA is a US-only law. If you’re in another country and plan to hire workers, be sure to check your country’s minimum wage laws instead.

Minimum Wage: The Basics

If you have employees, then you have to follow minimum wage laws. There are two levels of minimum wage laws you need to know: the federal minimum wage and your state’s minimum wage. Sometimes, you’ll have to understand city or county level minimum wage laws too.

As a rule of thumb, you follow the more stringent law. In other words, you make your minimum wage calculations based on the highest minimum wage requirement.

Some businesses, even though they’re small, have workers in different states or different cities. In that case, you follow the minimum wage law where the worker is located.

As of this writing, the federal minimum wage for every business in the US is $7.25/hour. But there are a few states where the minimum wage is around $15/hour and many states where the minimum is somewhere in between. Use this map from the US Department of Labor to look up whether your state follows the federal minimum or has a higher minimum.

You should also look up whether your city or county has a higher minimum wage requirement than your state. You can find this information in this database kept up-to-date by UC Berkely’s Labor Center. Some of these laws exempt very small businesses, so always look carefully. You might not have to follow these higher minimum wage requirements.

There are some exceptions to the FLSA minimum wage. If you qualify under these exceptions, you can pay your workers less than the standard $7.25/hour. We’ll cover some of these exceptions below.

Minimum Wage for Tipped Workers Can Be a Little Different

Under the FLSA, the minimum wage for “qualified tipped workers” is $2.13/hour instead of the standard $7.25/hour. Below, we go over how to make minimum wage calculations for qualified tipped workers.

You Get a Tip Credit for Minimum Wage Paid to Qualified Tipped Workers

If you employ workers who receive more than $30 in tips per month, then these workers are called qualified tipped workers. Under the right circumstances, you might be able to pay qualified tipped workers less than the standard minimum wage.

How to Calculate the Tip Credit

Under the FLSA, you can pay qualified tipped workers as little as $2.13/hour. This means that the worker makes $5.12/hour less than the standard minimum wage. You’ll have to keep track of all the tips the worker takes in and average their tips over the total hours they worked. As long as their average hourly pay rate is higher than the standard minimum wage, then you’re OK. But if the average falls below the standard minimum wage, then you have to make up the rest. This way, the worker gets paid at least the federal minimum wage of $7.25/hour.

Some employees have mixed job duties and only one portion of their job allows them to collect tips. In that case, you can take the tip credit only when the worker is working at the tipped part of their job. You have to pay them at least a minimum wage when they’re working at the non-tipped position. There’s a little bit of flexibility to this general rule if they work 30 minutes or less doing the non-tipped job. See the Labor Department’s guidance on how much flexibility you have, under what circumstances.

If you’d like to take advantage of this $2.12/hour minimum, be sure to understand the minimum wage calculations for tipped workers before you do it. For your convenience, here’s the Labor Department’s general guidance on how the tip credit works.

How the Tip Credit Works with State Minimum Wage Laws

If you wish to follow tipped worker minimum wage rules, you’ll also need to check your state minimum wage laws. Some states allow this credit but others do not. If you search the internet using the term “tip credit” and your state, you should be able to find the relevant information.

If your state allows this tip credit but has a higher minimum wage than the federal $7.25/hour, then the maximum credit you can take is $5.12/hour. For example, if your state’s minimum wage is $15/hour, then you have to pay your tipped worker at least $9.88/hour.

Here’s the Labor Department’s chart on which state lets you take the tip credit and pay less than the minimum wage in that state.

If You’re in the Food and Beverage Industry, You Get a FICA Tip Credit Too

An employer has to pay 50% of their employees’ FICA tax (Social Security and Medicare). If you’re in the food and beverage industry and you take the tip credit when you pay your tipped employees, you can take a FICA tax credit too.

Here are some instructions from the payroll software provider Gusto on how to calculate the FICA Tip Credit. It’s a bit complicated and tedious, so we won’t go into it here.

We honestly do not recommend you calculate the FICA tip credit by hand. Instead, we recommend you make all your minimum wage calculations using a payroll software like Gusto or any of the other payroll software we recommend. This way, you’re less likely to make mistakes.

Farm Worker Minimum Wage Are Different Too

We suspect that not many of our readers run a farm. But, for completeness, we want to mention that some agricultural workers are exempt from minimum wage and overtime payments.

To qualify, you have to fall under some very narrow exceptions of the FLSA. If you run a farm and want to find out under what circumstances you can be exempt from paying minimum wage or overtime, start with this fact sheet from the Department of Labor.

There Are Special Minimum Wage Rules for Youth Workers

The FLSA allows you to pay a lower minimum wage for workers under 20 years old. You’re allowed to pay them $4.25/hour for the first 90 consecutive days of their starting their job. This is a one-time, once per employee allowance. So, you can’t fire a worker on the 89th day, rehire them a day later, and pay them $4.25/hour for another 90 days. You run out of this special minimum wage forever for this worker on the 90th day.

If you’re thinking of using this exception for a new, younger worker, be sure to check your state’s minimum wage laws. If your states minimum wage laws apply to all workers regardless of age, then you can’t take advantage of this FLSA exception.

For more details on the youth minimum wage rules, see this Department of Labor fact sheet.

When Deciding on Worker Pay, Minimum Wage Isn’t the Only Consideration

When deciding how much you can pay a worker, minimum wage isn’t the only thing you need to think through. You’ll also need to pay attention to overtime pay. After all, if paying a worker minimum wage is already difficult for you, paying 1.5 times that amount for overtime can create even more cash flow problems.

Now that you understand minimum wage calculations, let’s take a look at how to calculate overtime pay in our next article: How to Calculate Overtime Pay, for Small Businesses.

Interested in starting and running a small business? Here’s the beginning of our step-by-step guide: What to do right after getting that great business idea.

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DISCLAIMER: This article does not constitute legal or accounting advice. Instead, it contains general information. The information gives you the background you’ll need to hit the ground running when you do go get advice from a lawyer or accountant. Only lawyers and accountants properly licensed in your state/country are qualified to give you legal or accounting advice.

Questions? Comments?