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.