If your business employs workers who receive tips for serving food and beverages and you pay Social Security and Medicare (FICA) taxes on tip income for these employees, you may qualify for a federal tax credit.
The FICA credit
This tax credit applies with respect to tips received by your employees in connection to providing customers with food or beverages, even if the food or beverages served are not for consumption on the premises.
For FICA tax purposes, these tips are treated as if you paid them directly to your employees, even though they were actually given by customers. You employees must report their tips to you, and you’re required to withhold and remit the employee’s share of FICA taxes. You’re also responsible for paying the employer’s share of those taxes.
This tax credit is claimed as part of the general business credit and is equal to your share of FICA taxes paid on tip income in excess of the amount needed to bring your employee’s wages up to $5.15 an hour. This means that if the tip income only brings an employee up to the $5.15-per-hour level, calculated monthly, no tax credit is available. However, you won’t need to worry about this calculation if you pay each employee $5.15 an hour or above, excluding tips.
It’s worth noting that the amount was frozen at $5.15 per hour by a tax law passed in 2007, when $5.15 was the amount of the federal minimum wage. Although the minimum wage has now increased to $7.25, the amount for credit computation purposes has stayed at $5.15.
A brief illustration
Say, for example, that a server working at your restaurant is paid $2 an hour plus tips, and that he works 160 hours over the course of the month. At the end of the month, his income is $320 in addition to $2,000 in reported cash tips.
Since the waiter is paid $3.15 less than the $5.15 rate for the FICA tax credit, he will be below the $5.15 rate by $504 (160 times $3.15) after 160 hours worked. Because of this, the first $504 of the waiter’s tip income will only serve to bring him up to the minimum rate. The remaining tip income will be $1,496 ($2,000 minus $504).
That means that if the waiter’s employer pays FICA taxes on his wages at the rate of 7.65%, the employer’s credit will be $1,496 times 7.65%, or $114.44 for the month.
While your share of FICA taxes is generally deductible, you can’t deduct FICA taxes that are paid with respect to the tip income you used to determine the credit since that would amount to a double benefit. However, you do have the option to refrain from taking the credit, which will allow you to still claim the deduction.
Take advantage of this tax credit
This tax credit on tips may be valuable to you if your business pays FICA taxes on your employees’ tip income. However, there may be additional rules that apply. Please reach out to us if you have further questions about this credit or the rules governing tipping and FICA taxes.