Restaurants can claim a federal income tax credit based on the share of FICA and Medicare ("employment") taxes that they pay on reported tip income to employees. In an ideal system, the employer's share of the payroll tax payable for the increased income would be paid by those who leave tips. After all, they are the ones who reward the server for their work. However, since there is no reasonable way to do this, the law requires the restaurant owner to pay the employer's share of labor taxes on tip income to the restaurant owner.
A quick update on why employers should be filing taxes on tips
If you already know why restaurants pay FICA and Medicare taxes for tips paid to employees by customers, skip to the next section. Otherwise, here's a quick rundown of the process:
Customers pay tips to bartenders, waiters, etc.
Employees who receive more than $20 in tip per month should notify their employer of the amount of tip they receive at least once per month.
Employers of tipped employees must also withhold the employee's share of employment taxes due on the reported tip income.
When employees are paid hourly wages, employers withhold income and labor tax.
When these employers pass withholdings on to the government, they are required to add the appropriate share of payroll taxes based on each employee's total salary and tip.
What is the FICA's tip credit?
The FICA-type credit, officially known as the "Credit for Portion of Employer Social Security Paid with Respect to Employee Cash Tips," aims to relieve companies that pay employer's share of employment taxes on the payroll for tips paid to your employees by someone else. Although the short name of the law only mentions FICA taxes, it allows employers to receive a credit of their federal income tax based on the FICA amount and Medicare taxes paid on tips reported to the employer. The credit reduces the employer's federal income tax by an amount based on the employer's payroll tax share paid on some of the reported tips.
To calculate the credit, qualified employers start by calculating an amount called the creditable tip. Typically, tipped employees receive an hourly rate well below the federal minimum wage. The purpose of the tip calculation is to eliminate tip credit eligibility, which is the difference between an employee's hourly wage with a tip and the federal minimum hourly wage in effect at the time the credit was enacted. To determine creditable tips:
Multiply the number of hours worked by the employee by $5.15 (the federal minimum wage rate in 2007 when the credit was enacted) to determine the employee's federal minimum wage amount.
Subtract the actual wages paid to the employee to arrive at the amount of tips that are not eligible for the credit.
Subtract the amount of inappropriate tips from the employee's total amount of tips to determine the amount of credible tips.
Multiply the credible tip amount by the combined FICA and Medicare rate, currently 7.65%, to determine the amount of credit available.
The following example illustrates this calculation:
Example: ABC, LLC operated a restaurant and employed an individual named M. In June, M worked 100 hours, received $400 in salary and $800 in tips. ABC is eligible for the US $52.40 credits based on the following:
Federal minimum wage: $515 (100 hours x $5.15)
Net tips not eligible for credit: $115 ($515 minimum - $400 salary paid)
Creditable Tip: $685 ($800 total tips minus $115 ineligible amount)
Total credit: $52.40 ($685 x 7.65%)
Note
1. To be considered a "tip," payment from the customer to the employee must meet four conditions:
Payment cannot be negotiated or dictated by employer policy.
The customer must have an unlimited right to determine the value.
The customer must have the right to determine who will receive payment.
The customer must not be compelled to pay the tip
For example, a service charge applied to an invoice for major holidays or catering events, which is then shared between servers, is generally not considered a tip that can be included in the tip calculation.
The FICA credit is included in the employer's income tax return as part of the general tax credit for businesses. This non-refundable credit cannot reduce tax liability below $0.
The expenses that a taxpayer claims for his employer's FICA taxes should be reduced by the amount of the FICA-type credit required that year.
FOR MORE INFORMATION OR TO SEE HOW ELLIOT KRAVITZ, ATP. CAN BEST HELP YOU WITH YOUR TAX FILING NEEDS, PLEASE CLICK THE BLUE TAB ON THIS PAGE.
THANKS FOR VISITING.
Elliot Kravitz, ATP