By Hillary West, Senior Manager
If you own a restaurant with tipped employees, you are likely eligible to take advantage of the FICA Tip Tax Credit that is available under Internal Revenue Code Section 45B. This is a very lucrative tax credit for business owners, as it is a direct offset of federal income tax liabilities.
How Does it Work?
The FICA Tip Tax Credit allows employers to take a credit on a portion of the employer FICA taxes paid on the employee tips. Employer FICA taxes are comprised of Social Security and Medicare tax, which is currently taxed at 7.65% of the gross wages.
As with most food and beverage businesses, tipped employees may be earning a wage that is less than the minimum wage. The tax credit is only allowed to be calculated on tips that are in excess of bringing the employee’s wage up to the federal minimum wage as of January 1, 2007, which was $5.15. The Small Business Work Opportunity Act of 2007 froze the federal minimum wage at $5.15 per hour for computation purposes, even though the federal minimum wage is currently at $7.25 per hour.
To be eligible for the tax credit, the following criteria must be met:
- You had employees who received tips from customers for providing, delivering, or serving food or beverages for consumption
- You paid or incurred employer social security and Medicare taxes on these tips
In addition, the credit only applies to tips that are received by the food and beverage employees, not other tipped employees.
The credit is calculated on the business’ corporate tax return and reported on IRS Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Income. If the business is a pass-thru entity, the credit will pass through to the business owners on IRS Form K-1 and the business owner will take the tax credit on their individual income tax return. One item to note – the credit is only allowed to offset income tax liabilities and cannot offset employer payroll tax liabilities. Also, this is a non-refundable credit, so if there is no tax due in the year the tax credit is earned, the credit will be subject to carryback and carryforward provisions of the Internal Revenue Code. Generally, these credits are carried back one year and forward 20 years.
How is it Calculated?
There are two scenarios to evaluate when calculating the credit; 1) when all employees are earning minimum wage and 2) when employees are earning less than minimum wage.
Here are a few example case scenarios:
- ABC Co. has a tipped employee that was paid $12 per hour and received $10,000 in tips for the year. ABC Co.’s tax credit is $76.50 ($10,000*7.65% FICA tax). If employees are earning minimum wage or above, you will simply take the total tips reported by the employees and multiply this by the employer FICA tax rate of 7.65%.
- John, a food and beverage worker, worked 2000 hours in 2018, earned $3.89 per hour and received $15,000 in tips. The income that will be reported to John on his W2 will be $22,780, which is calculated as $3.89*2,000 = $7,780 plus $15,000.
The total credit the employer can take is calculated as follows:
Gross wages $22,780
John’s wages based on $5.15 $10,300 (2,000 hours * $5.15)
Tip income above federal min $12,480 ($22,780 – $10,300)
FICA Tip Tax Credit $954.72 (12,480 * 7.65%)
Need Help Calculating the Credit on Your Tax Return?
CST Group, CPAs, PC is here to assist with calculating your FICA Tip Tax Credit and ensuring you are receiving the maximum deductions and credits on your tax return. We have the industry knowledge and will keep you in compliance with federal and state regulations. Call CST Group today!