If you run a restaurant or bar, you know that it can sometimes be tricky to manage tips and keep track of all the information. You’ve got to deal with cash tips, charged tips, FICA tip credit, minimum wage laws, tip reporting, and more.
All of these things can add up to a lot of work and headaches, especially when you factor in the tax implications.
But the good news is, once you understand some of the key terms related to tips, you can better prepare to manage them at your business and keep you and your employees compliant.
One of the more important ones to understand is FICA tip credits, which is something that every business owner should be aware of.
This is a complicated one, so we’ll take it slow and hopefully help you understand exactly what it is and how to handle it.
What is the FICA Tip Credit?
The FICA Tip Credit is a tax credit that allows businesses to take credit for a portion of Employer Social Security Paid on Cash Tips that are paid to an employee.
In the simplest of terms, it’s a way for employers to legally take credit for Social Security and Medicare taxes that are already being paid on employees’ tips. FICA stands for Federal Insurance Contributions Act.
The credit helps small businesses handle these taxes on tips. Those add up quickly if taxes aren’t taken care of.
The FICA Tip Credit is only available for businesses in the food and beverage industries with tipped employees who serve food or drink.
If you’re not sure your business qualifies, check with the IRS.
As an employer, you pay FICA taxes on your employees’ wages, including tips. With this credit, you can get some money back on the amount of FICA taxes. The IRS implemented the FICA Tip Credit to ensure that businesses are accurately reporting their employees’ tips and earnings to the government.
How do FICA taxes work with tipped employees?
It’s considered income (tip income) when a server, bartender, or other tipped employee receives a tip from a customer. Just like any other earnings for hourly wages or a salary, you’ve gotta pay the income tax.
FICA taxes are paid by both employees and employers on gross wages, which include tips. Therefore, FICA taxes are owed on tips, too. Because of that, it is important that tips are reported correctly and input into restaurant payroll software so that FICA taxes (and all other payroll taxes) are withheld correctly.
FICA taxes.
FICA includes two taxes: Social Security and Medicare, and both employers and employees pay FICA taxes on wages.
The total rate for Social Security is 12.4%, meaning employers and employees pay 6.2% each. The total rate for Medicare is 2.9%, meaning employers and employees pay 1.45% each.
Cash tips.
Some employees make cash tips, which are tips that they receive immediately (during or after their shift) in cash. This can include charged tips if you cash them out and give them to the employee as part of their cash tips. These are different from paycheck tips, which are tips that you pay out via payroll.
Cash tips or paid via their employer, the rules are the same regardless of how money changes hands. The total amount of tips that they receive (cash + charged tips) is considered gross income and must be paid to the IRS.
Cash tips can be a little tricky to handle. That’s because it’s important that the amount of cash tips received is accurately reported and entered into payroll. Although the employees already have the cash in hand, they (and their employer) must pay taxes on it via payroll.
How to calculate FICA Tip Credit.
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- Gather employee tip reports: Include all tips including cash tips, credit card tips, debit card tips, and any tips from tip sharing.
- Calculate total tips reported: Add up the total tips reported for each employee.
- Calculate total wages paid: Include direct wages and reported tips.
- Apply a minimum wage adjustment: The federal minimum wage is $7.25 per hour. Calculate the total wages, including tips that bring employee earnings up to the minimum wage.
- Calculate employers’ FICA: Remember that Social Security is 6.2% and Medicare is 1.45%.
- Calculate the credit for tips above minimum wage: Determine the amount of tips that exceed the amount required to bring the employee’s total earnings up to the minimum wage. The FICA tax credit is only claimed on these excess tips.
- Calculate the eligible FICA tip tax credit: Subtract the FICA taxes on tips that are used to meet the minimum wage from the total FICA taxes on all tips. The remaining amount is the FICA Tip Credit.
Here’s an example FICA tip credit calculation:
- Total tips reported by an employee: $10,000
- Total hours worked by the employee: 1,500
- Federal minimum wage: $7.25 per hour
- Direct wages paid: $2.13 per hour
- Minimum wage adjustment per hour: $7.25 – $2.13 = $5.12
- Total minimum wage adjustment for 1,500 hours: 1,500 * $5.12 = $7,680
The total tips are $10,000, with $7,680 of those tips are required to bring the employee’s wages up to the minimum wage. That makes the excess tips $2,320.
Excess tips: $10,000 – $7,680 = $2,320
Employer’s FICA tax on excess tips:
Social Security tax on excess tips: $2,320 * 6.2% = $143.84
Medicare tax on excess tips: $2,320 * 1.45% = $33.64
Total FICA tax credit: $143.84 + $33.64 = $177.48
How to claim FICA Tip Credit in 3 steps.
1. Make sure your business qualifies.
Not all business owners are eligible. Compensate your employees at least the federal minimum wage for all hours worked so that you qualify.
If your business is in a state with a higher minimum wage, of course, employees’ wages must meet that standard.
Total compensation may include any form of compsation, e.g. hourly wages, tips, service charges, lodging, and meals provided by the business.
2. Keep accurate payroll records.
First things first, it’s essential that you and your employees report tips and all forms of compensation correctly. (Individuals report tips on their individual income tax return).
Keeping accurate records is the foundation of the reporting you will need to claim the FICA Tip Credit.
If your employees make above the federal minimum wage, you may be eligible for the FICA Tip Credit.
The IRS explains, “Generally, the tax credit equals the amount of employer social security and Medicare taxes paid or incurred by the employer on tips received by the employee. However, employers cannot claim the credit for taxes on any tips that are used to meet the federal minimum wage rate.”
3. File form 8846.
To claim the FICA tips credit, you must fill out and file the tip credit form—IRS Form 8846—with your business tax returns. Follow the instructions on the form to make sure you qualify and fill it out correctly. You may want to create your own FICA tip credit report to find the correct amounts.
Stay compliant: Easily manage tips with Homebase.
Tip Manager automates the tip pooling process, meaning less time spent managing payroll. The tool automatically gathers data from your POS and timesheets, helping you remain compliant and accurate while managing tips.
FICA Tip Credit FAQ
What is FICA?
FICA (Federal Insurance Contributions Act) is a provision of the Fair Labor Standards Act (FLSA) that requires both employers and employees to pay taxes in order to fund Social Security and Medicare.
Do tips count as wages?
Yes, reported tips are considered gross income and must be included in an employee’s wages for purposes of FICA tax. In addition, they are subject to federal income tax withholding.
What is the credit rate for FICA?
The credit rate for FICA is 7.65%, 6.2% for Social Security, and 1.45% for Medicare, for wages up to $160,200. For wages above this amount, the rate is 1.45% for Medicare, plus the additional 0.9% Medicare tax for high earners.
Who is eligible for FICA Tip Credit?
Employers in the food and beverage industry are eligible for FICA tax credit. The tip tax credit for restaurants and bars require that employees be paid at least the federal minimum wage
What is the purpose of the FICA Tip Credit?
The IRS introduced the FICA Tip Credit to promote accurate reporting of tip income and earnings by businesses and facilitate proper tax and earnings documentation.
Do tips count as wages for the purpose of the FICA Tip Credit?
Yes, tips are treated as wages under the FICA Tip Credit. Employees must accurately record all tips, whether cash or credit, for income tax, Social Security, and other deductions.
What is the role of the employer in the FICA Tip Credit?
When it comes to the employer tip credit, employers are tasked with ensuring their employees’ accurate reporting of tips. They are required to verify and collect this information as needed.
What happens if employees earn more than the federal minimum wage?
Employers whose employees earn above the federal minimum wage may qualify for the FICA Tip Credit.
What is the formal name of the FICA Tip Credit?
The official designation of the FICA Tip Credit is “Credit for Portion of Employer Social Security Paid with Respect to Employee Cash Tips.”
Does the FICA Tip Credit apply to medicare taxes?
The FICA Tip Credit does apply to Medicare taxes, allowing employers a credit against their federal income tax for the FICA and Medicare taxes paid on reported tips.
Is the FICA Tip Credit refundable?
The FICA Tip Credit is not refundable. Unused credits can be carried back for one year or carried forward for up to 20 years.
Can the FICA Tip Credit be used to offset alternative minimum tax?
The FICA Tip Credit can offset the alternative minimum tax for taxable clubs using a significant portion of their net operating loss in a given year.
Who qualifies for the FICA Tip Credit in a club setting?
In clubs, the FICA Tip Credit applies solely to food and beverage employees, as defined by the IRS as those receiving tips for providing, delivering, or serving food or beverages.
Is the FICA Tip Credit available for both taxable and exempt clubs?
The FICA Tip Credit is accessible to both taxable and exempt clubs.
What is the impact of the FICA Tip Credit on a club’s taxable income?
The FICA Tip Credit can significantly reduce a club’s taxable income, especially for clubs with extensive food and beverage operations.
Remember: This is not legal advice. If you have questions about your particular situation, please consult a lawyer, CPA, or other appropriate professional advisor or agency.
