If you own a restaurant, bar or other business that serves food or beverages, do not overlook the FICA tip credit. This credit provides some relief for the federal payroll taxes you pay on your employees’ tip income. You are required to withhold FICA taxes (Social Security and Medicare) from your employees’ wages and to make matching contributions. Generally, both employer and employee pay these taxes at a rate of 7.65% (subject to certain limitations) for a total of 15.3%.
For FICA purposes, wages include tips received by employees, even though they are paid by someone else (customers). The FICA tip credit allows you to recover some or all of the FICA taxes you pay on employees’ tip income.
How the Credit Works
To calculate the credit, the first step is to determine the amount of “creditable tips.” Typically, tipped employees receive an hourly rate below the full minimum wage, and if tips fail to cover the difference between the reduced wage and the full minimum wage, the employer must make up the shortfall. The credit is not available for tip income that brings an employee’s wages up to the federal minimum, so that amount is excluded from total tips to arrive at creditable tips. The credit is equal to the amount of creditable tips times 7.65%.
For purposes of this calculation, the federal minimum wage is currently frozen at $5.15 per hour — its level in 2007, when the credit was first established — even though it has since increased to $7.25. So, for employers that pay their employees a base wage of $5.15 or more, there is no need to calculate creditable tips; the credit applies to all reported tips. That is the case in Chicago and elsewhere in Illinois, where state and local minimum wages for tipped employees are well above $5.15. In Chicago, for example, effective July 1, 2023, the minimum wage for small employers (four to 20 employees) is $15.00 per hour, with a $9.00 per hour minimum for tipped employees.
Related Read: Reaching the Tipping Point – Service Charges vs. Tips
Nicknack’s is a Chicago restaurant with 20 tipped employees. In 2023, each employee works 30 hours per week and receives a base wage of $9.00 per hour. As a group, the employees average $10,000 per week in tips. Because the employees’ base wages are more than $5.15 per hour, there is no need to calculate creditable tips — all reported tips are creditable. Nicknack’s FICA tip credit for the year, therefore, is $39,780 ($10,000 x 52 x 7.65%).
Tips vs. Service Charges
For purposes of the FICA tip credit, service charges — including automatic gratuities — are treated as wages rather than tips, so they are not eligible for the credit. To be considered a tip, a payment must be made at the customer’s discretion. If you are contemplating automatic gratuities or other mandatory service charges, be sure to consider the impact of these charges on your eligibility for FICA tip credits.
Get the Credit You Deserve
If you have not been claiming FICA tip credits, you are leaving a potentially significant amount of money on the table. So, be sure to claim the credit by filing Form 8846 — Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips — with this year’s federal income tax return. You may also be able to recover missed credits for the previous three years by filing amended returns.
For more information about FICA tip credits, please contact Brian Israel at [email protected]. Visit ORBA.com to learn more about our Restaurant Group.