DOL Clarifies Application of Minimum Wage and Tips Under the FLSA’s Commissioned Employee Overtime Exemption

On January 5, 2026, the U.S. Department of Labor’s Wage and Hour Division issued an opinion letter (FLSA2026-4) clarifying how employers should apply the Fair Labor Standards Act’s (FLSA) Section 7(i) overtime exemption for certain commissioned-paid employees. 

The letter addresses two questions that frequently arise in federal wage-and-hour litigation and in compliance audits:

1. Whether the federal minimum wage or a higher state minimum wage must be used when determining whether an employee satisfies Section 7(i)’s minimum pay requirement; and
2. Whether and to what extent employee tips must be counted when determining whether an employee is primarily paid by commissions for purposes of Section 7(i)’s requirements.

Employers in the hospitality, retail, and service sectors—particularly those that rely on service charges, commissions, or tip credits—should carefully review the opinion letter, as it provides important guidance on overtime classification and compliance under federal law.

The Legal Framework Behind Section 7(i) 

The FLSA generally requires employers to pay non-exempt employees at least the federal minimum wage, currently $7.25 per hour, for all hours worked. The statute also requires overtime pay at a rate of no less than one and one-half times the employee’s regular rate for all hours worked over 40 in a workweek. 

Section 7(i) of the FLSA, however, provides a limited exemption from the overtime requirement for certain employees of qualifying “retail or service establishments” who are paid primarily on a commission basis. To claim the exemption, an employer must qualify as a “retail or service establishment” and meet two pay-related conditions:  

1. the employee’s regular rate of pay must exceed one and one-half times the applicable minimum hourly rate under Section 206 of the FLSA (the “Minimum Pay Standard”); and
2. more than 50% of the employee’s “compensation” over a designated representative period (not less than one month) must consist of commissions. 

29 U.S.C. § 207(i)(1)-(2). 

The opinion letter focuses squarely on how these two pay requirements should be applied when the employees work in states with higher state minimum wages and when employees receive tips in addition to commissions or service charge payments.

The Federal Minimum Wage Controls Section 7(i)’s Minimum Pay Standard

The Department of Labor confirmed that, for purposes of Section 7(i), the federal minimum wage—and not a higher state or local minimum wage—controls the Minimum Pay Standard. The Department of Labor explained that Section 7(i)(1) expressly incorporates the federal minimum wage. 

As a result, an employee satisfies Section 7(i)’s Minimum Pay Standard so long as the employee’s regular rate exceeds one and one-half times the federal minimum wage. At present, that threshold is $10.875 per hour (i.e., $7.25 × 1.5). For practical purposes, an employee’s regular rate must therefore be at least $10.88 per hour in any workweek in which the employer seeks to apply the exemption, regardless of whether state law requires a higher minimum wage.  

The DOL emphasized, however, that this interpretation does not relieve employers of their obligation to comply with more protective state or local wage laws. Employers must still comply with all applicable state minimum wage requirements. A violation of state law may give rise to state-law liability, but it does not, by itself, defeat the FLSA’s Section 7(i) exemption so long as all its statutory elements are otherwise met.

Tips Are Not Commissions, But May Constitute “Compensation” for Purposes of Section 7(i) in Limited Circumstances

The opinion letter also addresses whether tips must be included when determining whether commissions comprise more than half of an employee’s compensation under Section 7(i)(2).  The DOL stated that tips are not commissions for purposes of the FLSA and are generally not considered compensation paid by or on behalf of the employer for employment, because tips are discretionary payments made by customers.  

The DOL explained, however, that tips may constitute “compensation” under Section 7(i)(2) where an employer relies on a portion of an employee’s tips to satisfy its wage obligations. Specifically, to the extent an employer takes a federal, state, or local tip credit and uses a portion of an employee’s tips to meet minimum wage requirements, that portion of the tips is considered “compensation” for purposes of determining whether the employee is primarily paid by commissions. The opinion letter provides detailed examples illustrating this distinction. Where an employer does not take a tip credit, employee tips are excluded entirely from the Section 7(i)(2) calculation. Where a tip credit is taken, only the amount of tips actually used to satisfy the employer’s wage obligation is included as compensation, while the remaining tips are excluded. 

The DOL noted, however, that its interpretation of this aspect of Section 7(i) does not apply to businesses in Maryland, Virginia, West Virginia, North Carolina, and South Carolina due to the Fourth Circuit’s ruling in Wai Man Tom v. Hosp. Ventures, 980 F.3d 1027, 1039 (4th Cir. 2020), which held that all tips received by servers qualify as “compensation” for purposes of Section 7(i)(2). Given these conflicting interpretations, the treatment of tips under Section 7(i)(2) remains an unsettled issue notwithstanding the DOL’s guidance. 

Finally, the DOL reaffirmed the distinction between tips and service charges for purposes of Section 7(i). While tips are discretionary payments determined by customers, mandatory service charges—such as a fixed percentage automatically added to a customer’s bill—are treated differently under the FLSA. When service charges are added to the sale of goods or services and distributed to employees, they generally constitute commissions, not tips. As a result, service charge payments may be counted fully as commissions when determining whether an employee’s compensation is primarily commission-based under Section 7(i)(2). This clarification is significant for hospitality employers that rely on mandatory service charges rather than traditional tipping models, as such payments may support application of the overtime exemption even where employee tips do not.

The opinion letter was issued pursuant to the Portal-to-Portal Act, which permits employers to rely on official interpretations of the Department of Labor as a defense to liability under the FLSA, but expressly contemplates that such interpretations may later be determined by judicial authority to be invalid or of no legal effect. 29 U.S.C. § 259. The opinion letter expressly acknowledges existing contrary judicial authority in the Fourth Circuit and cautions employers in that jurisdiction not to rely on the opinion letter to the extent it conflicts with controlling precedent. 

Employers relying on Section 7(i) should consider reviewing their pay structures and classification decisions in light of this guidance and consult experienced labor and employment counsel to mitigate potential wage-and-hour exposure.