Employment Law Update: Department of Labor Clarifies FLSA Exemption Applicable to Retail and Service Employees
Date: January 29, 2026
The FLSA requires employers to pay non-exempt employees one and one-half times their regular rate of pay for any hours worked over forty hours in a workweek. Section 7(i) of the FLSA exempts retail and service employees from the overtime requirement if: (1) their regular rate of pay exceeds 1.5 times the applicable minimum wage; and (2) more than 50% of their total earnings in a representative period consist of commissions on goods or services. The representative period must be at least one month, but not longer than one year.
Restaurant operators in a state where the state minimum wage exceeds the federal minimum wage sought clarity from the DOL on two questions. First, whether to use the federal or state minimum wage to determine whether the minimum pay standard of Section 7(i) is satisfied. Second, if tips qualify as compensation in determining whether more than half of the employee’s total earnings consist of commissions.
Relying on the plain text of the statute, the DOL clarified that the federal minimum wage is used to meet the “regular rate of pay” threshold. As such, currently, employees whose regular rate of pay exceeds $10.88 an hour may qualify for this exemption.
In addressing the next inquiry, the DOL acknowledged that bona fide tips are not “commissions” for Section 7(i) purposes, although service charges typically are. Further, because tips are within the customer’s discretion, they are not typically considered “compensation.” That said, the FLSA permits an employer to take a “tip credit” of up to $5.12 per hour against the $7.25 federal minimum wage and use that credit to cover part of the employer’s wage obligations to the employee. The DOL concluded that when an employer uses this credit to satisfy its wage obligations, the credited amount counts as compensation under Section 7(i) and must be treated as guaranteed earnings when determining if an employee is primarily paid by commission.
Employers who operate retail or service establishments should take note of this guidance when classifying their employees as exempt or non-exempt. Employers should also be mindful that applicable state laws may impose additional restrictions.
If you have any questions about employee classification, please contact Whiteford’s Labor and Employment team.
The information contained here is not intended to provide legal advice or opinion and should not be acted upon without consulting an attorney. Counsel should not be selected based on advertising materials, and we recommend that you conduct further investigation when seeking legal representation.