CORPORATE TAX | 03/24/2024
If you’re an employer with a business where tipping is routine when providing food and beverages, you may qualify for a federal tax credit involving the Social Security and Medicare (FICA) taxes that you pay on your employees’ tip income.
Credit fundamentals
The FICA credit applies to tips that your staff members receive from customers when they buy food and beverages. It doesn’t matter if the food and beverages are consumed on or off the premises. Although tips are paid by customers, for FICA purposes, they’re treated as if you paid them to your employees.
As you know, your employees are required to report their tips to you. You must:
- Withhold and remit the employee’s share of FICA taxes, and
- Pay the employer’s share of those taxes.
How the credit is claimed
The credit is claimed as part of the general business credit. It is calculated based on the employer’s share of FICA taxes paid on tip income that exceeds the amount necessary to raise an employee’s wages to $5.15 per hour. This means no credit applies to tip income used solely to meet the $5.15-per-hour wage threshold, calculated on a monthly basis. Employers who pay their employees at least $5.15 per hour (excluding tips) do not need to perform this calculation.
Important: A 2007 tax law set the credit calculation rate at $5.15 per hour, which was the federal minimum wage at the time. Although the current minimum wage is $7.25 per hour, the $5.15 rate remains unchanged for credit computation purposes.
Let’s look at an example
Consider a scenario where a server at your restaurant earns $2.13 per hour plus tips. Over the course of a month, she works 160 hours, earning $340.80 in wages ($2.13 × 160) and receives $2,000 in cash tips, which she reports to you.
The server’s hourly wage of $2.13 is $3.02 below the $5.15 threshold. For 160 hours worked, this shortfall amounts to $483.20 ($3.02 × 160). The first $483.20 of her tip income is used to meet the $5.15-per-hour minimum wage requirement. The remaining tip income is $1,516.80 ($2,000 − $483.20).
As the employer, you pay FICA taxes at a rate of 7.65%. Therefore, the credit you can claim for the month is $116.03 ($1,516.80 × 7.65%).
Important Note: While the employer’s share of FICA taxes is typically deductible, the portion of FICA taxes related to tip income used for credit calculations cannot be deducted to avoid a double benefit. However, if you choose not to claim the credit, you can deduct these FICA taxes instead.
Get the credit you deserve
If your business pays FICA taxes on tip income paid to your employees, the tip tax credit may be valuable to you. Other rules may apply. Contact us if you have any questions.