Restaurants

Understanding the FICA Tip Credit for Restaurants, Bars, and Other Food and Drink Establishments

With the official name of Credit for Portion of Employer Social Security Paid with Respect to Employee Cash Tips, the informally-dubbed “FICA tip credit” is a tax benefit for employers in the food and beverage industry. This tax credit can save restaurant owners a significant amount of money as it directly reduces the amount of taxes owed.

The FICA tip credit was codified in 1993 after the restaurant industry lobbied against a rule reversal in 1987, where restaurant employers were held responsible for FICA taxes on employee tips up to the minimum wage but the employees had to pay taxes on the full amount. When the minimum wage ceiling was removed in 1987, the FICA tip credit was introduced. It was enacted in 1993 to increase revenue to Social Security, but allows restaurant owners to reduce their federal income tax.

Eligible employers in the restaurant industry can still claim the FICA tip credit if these payroll taxes are paid on their employees’ tips.


Do Employers Have to Pay FICA On Tips?

Yes. According to the IRS, employers with tipped employees are obligated to report tip income and pay the employer’s share of Social Security and Medicare taxes (FICA). Employers have this obligation regardless of what type of business they own and whether tips are received through cash, credit cards, or other electronic payments, and whether tips are individually received by employees or split under a tip-sharing or tip jar arrangement with the entire staff.

Until 1987, employers in the restaurant business in particular only had to pay the FICA portion up to minimum wage at the time. After the minimum wage cap was eliminated, employers needed to start paying their share of FICA on wages and tips regardless of the amount.

Are Tips Subject to FICA Tax?

Yes, both the employee and employer must pay FICA taxes on tip income, even though the customers are paying the tips.

FICA must also be paid by the employee and employer on non-tip income that is often mistaken for tips, such as:

  • Gratuity or “auto-grat” charges for large parties and special orders
  • Delivery fees charged to the customer regardless of tips
  • Bottle service charges

If any of these charges are paid to the employee, they are considered wages and not tips, and cannot be used for the FICA tip credit.

Employees must report their tips to you if they receive more than $20 in a calendar month. The IRS suggests using Form 4070A, Employee’s Daily Record of Tips, inside Publication 1244 to keep daily records of tips received so that they can correctly report the amounts in a timely manner, but other systems may be used to account for both cash and electronic tip reporting. If an employee receives less than $20 in tips for the month, it is their responsibility to report these tips on their personal tax return and pay the appropriate FICA portion, but they do not need to report it to you for FICA withholding.

The gross amount of the tips within the designated pay period, typically a weekly paycheck in the restaurant industry, is used to compute both the employer’s and employee’s share of FICA taxes.

Who is Eligible For the FICA Tip Credit?

Currently, only businesses in the restaurant industry are eligible for the FICA tip credit.

Your business must have tipped employees and customarily provide, deliver, or serve food and/or beverages. This would include restaurants, cafés, bars, coffee shops, and other establishments where it is common for employees to receive tips from customers. While hotels, spas, and hair salons are also likely to have tipped employees and may offer food and drink for purchase, it is not the focal point of the business. Therefore, these types of businesses are ineligible for the FICA tip credit. The same rules for reporting employee tips and ensuring both the employer and employee pay their share of FICA tax are still mandated.

Provided that your business is an eligible food and drink establishment and the employer’s share of FICA taxes were paid for at least one tipped employee during the year, you can claim the FICA tip credit. If none of your employees earned at least $20 per month in reportable tips which would necessitate this tax payment, you cannot claim the FICA tip credit.

How is the FICA Tip Credit Calculated?

The FICA tip credit is calculated by determining the amount of creditable tips. Since the tipped wage tends to be below the federal minimum wage, the creditable tips is the portion that exceeds the difference between the tipped wage and federal minimum wage that was in effect in 2007 ($5.15 per hour).

For instance, if your employee worked 120 hours and received $500 in tips in December 2020 at a tipped wage of $3.75 per hour, they received $450 in wages. Had they received $5.15 per hour, the employee would’ve received $618 not counting tips. To compute the tip credit, the $500 in tips is reduced by $168 (the difference between the $618 federal minimum wage and $450 tipped wage) so $332 is the creditable tip amount for December 2020 for that employee.

The credit is worth 7.65% of the creditable tips (with additional calculations if any employee’s total compensation exceeded the FICA cap, which was $137,700 for 2020). For this example using just one employee, the FICA tip credit is $25. The credit must be calculated to include all tipped employees. If employees are paid more than $5.15 per hour, the creditable tips portion increases.

Jeff Lipsey and Associates can assist restaurant and bar owners, and other business owners in the food and beverage industry, with properly calculating FICA tip credits and ensuring that employee tips are correctly reported. Contact us today to speak to one of our friendly and professional business tax experts.

Restaurants: An Industry Where Percentages Matter

Restaurants: An Industry Where Percentages MatterIn a conversation with a new contact last week, we discussed that in new businesses, trying to set “ideal” percentages is pretty much meaningless. In one industry where that is not the case however is the restaurant industry.

If you check my Linked-In and About Me pages, you’ll notice I mention I was both a manager and then general manager of a local successful restaurant. About halfway into my stay at the company, the owners made a shift to focus on the “best” percentages–and the results were phenomenal.

If you are getting ready to open a restaurant then a focus on Fixed Costs (Rent, Utilities, Permits, etc) as a percentage of potential sales (10-15%) is important. Restaurants with low fixed costs are able to charge a lower base price for all meals than their competitors while also maintaining profitability. In my opinion, there are 3 major percentages (cost/sales) that already-established restaurants should focus on to increase profitability: Food Cost (25-30%), Labor Cost (25-30%), and Variable Costs (10-15%).

In a restaurant with gross sales of $100,000 a month (a small to mid-size restaurant), a 1% reduction in costs is an extra $12,000 of profit each year.

Variable Costs

These expenses are not glamorous to think about but every restaurant must go through. They involve: Reducing paper usage, limiting your linens expenses and choosing the right cleaning products. When I read an article about a NY Restaurant with Zero Waste I am breath taken–their variable costs percentages must be phenomenal!

In the end, the best way to reduce these expenses is to remain vigilant with your staff, constantly search for savings with your vendors and install the most efficient fixtures that you can afford. As a restaurant owner, I would estimate your variable costs should be around 15% of your sales.

Labor Cost

Restaurants and the cost of their labor will likely always be a contentious issue. I never could just look at the labor cost as a figure of dollars and cents because for every $1 of labor you cut, you essentially reducing the salary of one of your workers by $1. Restaurant owners cite high labor cost as a main reason to not pay their employees more, when it is typically the lowest paid workers who are doing the most strenuous of tasks.

On the other hand, it is very important for owners and managers to make sure their workforce is efficient. Restaurant owners must be willing to adequately train their staff and treat them with the respect they deserve. Your staff has just as much power to influence your sales as your menu, so if you treat them well they will return the favor by selling more to your current clientele.

Don’t be afraid to pay your employees well and expect a lot out of them. Instituting and maintaining a well-paid and well-rested staff will reduce employee turnover and create goodwill with your customers.

What do I mean by well paid and well rested? Don’t pay minimum wage and make sure your wages are above average for your area. Give your employees sick days and vacation days, even if they’re only in small amounts.

As a restaurant owner, you should expect to pay around 25-30% of sales in labor costs. If you’re too low and you’re still unprofitable then expect to reduce costs in other areas; if you’re too high then wait to see if we have to raise prices then redetermine. The last thing you want to do is lay off or reduce hours, but if you notice an inefficiency then don’t be afraid to act either.

Food Cost

Every restaurant can improve their food cost percentage even if you think your restaurant already does pretty well. The first step in reducing your food costs is to determine exactly how much each item on the menu costs to make per unit. It is not an easy task to find out exactly how much each item costs but that is the only way to really reduce your food costs significantly (you have to know what your costs are first before you can change anything). If you have different portion sizes and prices for lunch and dinner then you should have separate numbers for each.

When you break down the cost of each item, keep a spreadsheet with the ingredient, portion size, and cost per ingredient for every one of your items on the menu from appetizers, main courses and yes, even drinks (especially alcoholic drinks). Then add up the cost of each menu item and then factor in a waste percentage of 10% (multiply the cost by 1.1)–this way you can account for all the times you mess up an order and have to remake it. If your error rate is less than 10% then awesome as that will only increase your profitability but it is best to error on the side of caution when setting your prices.

The next step is to divide the new cost by the price of the item on your menu; in an ideal world your percentage would be 30% or lower if you’re not a fast-food franchise. Create a new menu with your prices compared to the food cost percentage. You will probably be surprised that some items you’re selling on the menu you are making a lot of money on (food cost of 20%) and others not so much (food cost of 40% or more).

If you’re really good at tracking your sales, you can see how often each item on your menu is ordered; customers are not dumb and they know when they are getting a great deal compared to when a menu item is too highly priced. The goal is to have the average of all items to be 30% or lower so don’t go raising your prices… yet. Look at your higher food cost items to see what is the cost driver: Is it waste? Is it delivery cost? Expensive item? Before raising your prices find out if it makes sense to change the dish to make it less expensive without sacrificing the quality.

I have three examples where I significantly reduced food cost percentages while at the restaurant and I did so by 1) raising prices, 2) reducing waste and 3) reducing delivery charges.

1) Raising Prices – We were always hesitant about raising prices, as we were already viewed at having expensive (yet high quality) food for our area. There was one item I was adamant about raising prices on and that was one of our fish options. We dealt with a lot of seafood and many consumers can’t tell the difference between them (one of the many reasons seafood fraud is so rampant today), so they would typically go for the item with the lowest price. Unfortunately, this was also our lowest-margin fish option so every time they chose this item we lost money (compared to if they ordered something else). When changing prices, never raise the price of the most expensive dish (of a comparable nature) on the menu and never lower a price below the least expensive dish on the menu–but feel free to move around in between. Consumers might notice that you raised a price on one dish by as much as 15%, but as long as you kept the other prices the same they are likely to forgive you; that is exactly what happened in our case.

What happened was the demand for that dish did reduce so we only saw a minor increase in sales from the increase in price. However, the cost/dish was now below 30% and the individuals who found it too expensive to purchase that dish went on instead to purchase other, more higher-margin items, on our menu. It didn’t matter which option they chose, we were guaranteed to make our money on it.

Note: Raising your highest-priced dish even higher is how you can alienate your customers.

2) Reducing Waste – Bars and restaurants who serve fries at their restaurants literally sell them by the ton on a monthly basis. Most bars buy them pre-packaged and frozen, so their waste is already quite low (that is also why most fries taste the same). For the restaurants who still take the time each day to peel each potato by hand (a worthwhile investment), be mindful of both the size of the potato and how they are peeled. I have an excellent example on this: One of my first changes as a GM was I changed the way our workers peeled the potatoes.

What seems now like an obviously bad practice, the cooks used to peel potatoes using paring knifes. The reason? Our potatoes were pretty massive, weighing nearly a pound each and frankly they could cut through 2 to 3 times as many potatoes in the same amount of time than if they used a potato peeler. At this point I did an experiment: Use potato peelers for a week to see how much we save on waste from cutting potatoes.

The result? The cooks cut as much as 35% fewer potatoes while not taking that much longer each morning. In fact, I calculated I could have hired an additional employee to cut potatoes all day every day and it would still have saved money from the old method. Food costs were significantly reduced on a magnitude of $10,000 or more each year just from that one change alone.

3) Delivery Method – This was probably my most difficult change that I made and it involved getting two of our vendors to work together. We purchased a lot of fish every day and all of it fresh. We wanted to use the most sustainable fish we could, which involved us paying over $1.20/pound of overnight shipping using FedEx from the North Atlantic coast. Our vendor would cut up and package our fish and put it on the truck for overnight delivery. No offense to FedEx here, but that is not how food should arrive at a restaurant kitchen!

We used a couple of different vendors to get our fish, and they all worked out of the same area and drove the same routes every day. Even though these guys were competitors they all knew each other and worked well with each other, and that is how we were able to reduce our food costs. Every night, the vendor that packed the boxes for overnight delivery instead put them on a freight train to take them half way down the coast. Our other vendor, which frequented the same area, would then pick up the fish from the train and deliver the fish to our door.

The result: While we were paying $1.20/pound to FedEx every day, we instead paid the freight train $0.15/pound, we paid our first vendor an additional $0.35/pound for their trouble, and an additional $0.25/pound to the second vendor. So everyone involved increased profitability (sorry FedEx) for a total savings of $0.50/pound (about 3% on that dish alone). That doesn’t sound like a lot but when you sell thousands of pounds of fish each year, those savings are pure profit

Conclusion

You’ve made it with me this far so you will see that I have estimated return of sales for the owner of between 10-15%. Many restaurant owners and shareholders strive for 20% of sales for profit which is an excellent goal.

It does take effort to come up with solutions to reduce costs but the changes you make will add up to a lot of money when you have a lot of volume over the period of several years. But the first step in making these changes is to find out what your exact percentages are and then identifying where you need to improve. If you could save $100,000 over a 10 year period by making a few changes now, why wouldn’t you?

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