If you’re an employer in the food and beverage industry, when you hear “high employee tips” it probably sounds a lot like “high FICA taxes.”
The truth is that businesses in the service sector – where tipping is not only customary but increasingly commonplace – bear the burden of an elevated business income tax liability. Because all wages are wages, tips come with both the possibility of high employee earnings and the potential for high employer FICA tax contributions.
But what if there was a way to turn those high FICA tax contributions into a business benefit? What if instead of a tax expense, “high employee tips” could be a credit to the tune of tax savings?
Well, drumroll, please...
...The FICA Tip Credit, designed to mediate these very tax troubles, offers an answer to both of these questions.
In this article, you’ll learn why the FICA Tac Credit may be a valuable opportunity to save on your business income taxes.
By reading to the end, you’ll know:
- how to determine your eligibility status
- how to calculate your annual FICA Tax Credit
- And how to claim valuable tax savings on tipped income
Understanding FICA taxes and the FICA Tip Credit
Managing a food and beverage business means being familiar with relevant tax requirements, particularly FICA taxes for both wages and tips.
So, if you are an employer in the food and beverage industry and you aren’t aware of either how the Federal Insurance Contributions Act (FICA) taxes work or how the FICA Tax Credit may be able to lighten your tax liability, here’s some helpful homework for you:
Read our article, Can the FICA Tip Credit Lower Your Business Income Taxes?
How does the FICA Tip Credit work for employers in the food & beverage industry?
The FICA Tip Credit offers food and beverage industry employers a way to reclaim a portion of the FICA taxes paid on employee tips. It provides both the potential for significant tax savings and an incentive for accurate tip reporting.
This tax provision, which credits the full 7.65% FICA tax on eligible tips back to qualified employers, is designed to alleviate the higher tax burden that employers handling tipped income experience and encourage transparent financial practices within the service industry.
Many food and beverage businesses already greatly benefit from this underrated tax break.
If you’re an employer in a tipped sector, don’t let this valuable opportunity pass you by!
Consider the following to determine if the FICA Tip Credit could turn your FICA contribution on tipped income into tax savings:
- Do you qualify?
- How much can you save?
- What paperwork is involved?
Let's unpack each of these key aspects, including the how-to processes for determining eligibility, calculating the credit, and navigating the documentation and compliance requirements.
Who qualifies for the FICA Tip Credit?
The FICA Tip Credit is designed exclusively for employers whose employees earn tips as a significant part of their income. This typically includes restaurants, bars, and similar establishments where tipping is common practice. However, not all businesses within these industries automatically qualify for the credit.
To be eligible for the FICA Tip Credit, you must meet the following conditions:
Operate a food or beverage establishment:
Your operation should be a food or beverage venue where tipping is a standard practice. This applies to both sit-down dining and certain take-out services where tipping occurs.
Guarantee employees report tips for payroll:
Your team must report their tips to you and they must be included in their payroll. This step is crucial because it forms the foundation for calculating your credit. As the employer, it's your job to make sure all tips are fully and accurately reported.
Pay your contribution of FICA taxes on wages and tipped income:
You need to have paid the employer's share of FICA taxes on your employees’ taxable income including tips. The credit you can claim is specifically for the taxes paid on tips above the federal minimum wage.
How to calculate your FICA Tip Credit?
Calculating the FICA Tip Credit requires careful attention to the amount of tips reported, the wages paid to employees, and the application of FICA tax rates. If you are a food and beverage industry employer, knowing how to correctly calculate the FICA Tip Credit is essential to unlocking its tax savings.
Need help with this?
Here is the step-by-step process to accurately calculate your FICA Tip Credit:
4 simple steps to calculating your FICA Tip Credit (with practical examples)
1. Identify the total amount of tips reported on payroll:
Start by determining the total amount of tips your employees reported during the tax year.
2. Determine the amount of tips used to meet the minimum wage:
Calculate the portion of your employee tips that was needed to bring their wages up to the federal minimum wage. These tips are not eligible for the FICA Tip Credit.
3. Calculate the amount of tips that exceed the minimum wage:
Subtract the tips used to meet the federal minimum wage from the total reported tips. These remaining tips are eligible for the FICA Tip Credit.
4. Apply FICA tax rates to the amount of tips that are eligible for the FICA Tax Credit:
Apply the current FICA tax rates of 6.2% for Social Security and 1.45% for Medicare to the total amount of eligible tips to determine your FICA Tip Credit.
Let's illustrate this process with some examples:
Example #1:
Federal Minimum Wage: $7.25 per hour.
Employee's Direct Wages: $5.00 per hour.
Reported Tips: $360 for the month.
Hours Worked: 160 hours in the month.
How much is your FICA Tip Credit?
- What is the total amount of reported tips?
$360 in reported tips
- What is the amount of tips used to meet the minimum wage?
$7.25 - $5.00 = $2.25 per hour
$2.25 per hour X 160 hours = $360 in tips needed to meet the minimum wage
- What is the amount of tips that exceed the minimum wage?
$360 in reported tips - $360 in tips needed to meet the minimum wage = $0 in tips exceeding the minimum wage
In this scenario, because your employee reported $300 in tips, which is less than the $360 needed to meet the minimum wage, there are no excess tips eligible for the FICA Tip Credit.
This example demonstrates a situation where the reported tips do not exceed the amount used to satisfy the minimum wage requirement, thus not qualifying for the credit.
But, what if your employee reports $500 in tips?
Example #2:
Federal Minimum Wage: $7.25 per hour.
Employee's Direct Wages: $5.00 per hour.
Reported Tips: $500 for the month.
Hours Worked: 160 hours in the month.
How much is your FICA Tip Credit?
- What is the total amount of reported tips?
$500 in reported tips
- What is the amount of tips used to meet the minimum wage?
$7.25 - $5.00 = $2.25 per hour
$2.25 per hour X 160 hours = $360 in tips needed to meet the minimum wage
- What is the amount of tips that exceed the minimum wage?
$500 in reported tips - $360 in tips needed to meet the minimum wage = $140 in tips exceeding the minimum wage
- What is your FICA Tip Credit?
Social Security tax rate = 6.2%
Medicare tax rate = 1.45%
6.2% + 1.45% = 7.65% FICA tax rate
7.65% FICA tax rate X $140 in tips exceeding the minimum wage = $10.71 FICA Tip Credit
In this scenario, your employee reported $500 in tips for the month, and only $360 of the tips are allocated toward meeting the federal minimum wage. This leaves $140 in excess tips. By applying the FICA tax rates of 6.2% for Social Security and 1.45% for Medicare, totaling 7.65%, to the $140 results in a FICA Tip Credit of $10.71.
This demonstrates how you can benefit from the FICA Tip Credit because the $10.71 FICA Tip Credit offsets part of the FICA taxes you owe on the employee’s tips, specifically those not needed to satisfy the federal minimum wage.
Seem complicated? Check out our webinar covering how HCM technology can help with challenging HR tasks like tax credit calculations, payroll deductions, and more!
What documents are needed to claim your FICA Tax Credit?
To apply for the FICA Tip Credit, it's crucial to be prepared with the necessary documentation.
Here's what you’ll need to do to be ready to make your claim:
Track every tip, big or small:
Keeping meticulous records of employee-reported tips is crucial for both compliance and maximizing your credit potential. Remember, this includes all tips, whether they're cash or electronic. Think of it as building a strong foundation for your credit claim!
Make sure no tip goes untaxed:
Every tip reported by your employees needs to be factored into your Social Security and Medicare tax calculations. This ensures you're paying the right amount of taxes while also claiming the credit you deserve.
File the right forms, right on time:
The following forms are essential for claiming the FICA Tip Credit:
- Form 941: This quarterly form reports wages, tips, and withheld taxes, keeping you on top of your tax obligations.
- Form 8846: This form is your ticket to claiming the credit! It allows you to calculate and claim a credit for the employer portion of Social Security and Medicare taxes you paid on tip income exceeding the federal minimum wage.
- Form and 1120 and 1120S: You will provide your Form 8846 to your CPA. Once your CPA has completed your Form 1120 / 1120s, then they will submit this tax credit form together with your annual business tax filing.
(Note: It is critical to keep your CPA in the loop once you complete your calculation and form 8846, so that they can consolidate your year-end tax forms and provide an accurate tax filing for your business.)
By following these simple steps and keeping accurate records, you leverage the valuable tax savings offered by the FICA Tip Credit.
Ready to amplify your tax savings with the FICA Tip Credit?
Now you understand how the FICA Tip Credit can significantly lighten your tax load, turning the challenge of high employee tips into an opportunity for substantial tax savings.
But opportunity without action won’t score you the tax credit you deserve.
Here at Combined, our team of experienced payroll specialists has assisted many service sector employers, making sure to minimize their tax expenses and maximize their savings. And we are committed to helping you do the same.
Ready to take action and let your ledger of tipped income lead you to a better financial outcome?
We are too!
This article is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel for legal advice.
