Employees who work in the restaurant industry and earn gratuities from customers are required to report monthly tips in excess of $20 to their employers. Employers are then required to withhold both the employee’s and the employer’s share of employment taxes on the tip income reported.
The FICA Tip Credit was enacted to provide tax relief to a business paying employment taxes on tip income and can potentially save employers hundreds of dollars per employee.
To calculate the credit, employers must first calculate an amount known as “creditable tips.” Tipped employees are typically paid an hourly rate below the federal minimum wage rate. The creditable tips calculation removes the tip income that makes up the difference between the employee’s hourly wage and the federal minimum wage. The steps in calculating the credit available are:
Multiply the number of hours the employee worked times the federal minimum wage rate (federal minimum wage amount)
Subtract from that number the actual wages paid to the employee (tips not eligible for the credit)
Subtract the amount of tips not eligible for the credit from the total tips reported by the employee (creditable tip amount)
Multiply the creditable tip amount by the combined FICA and Medicare tax rate (currently 7.65%) to determine the credit available
Example: Restaurant LLC operates a restaurant and employs Jane. Jane worked 150 hours and received $600 in wages and $900 in tips last month. The federal minimum wage is $7.25 and the FICA and Medicare tax rate is 7.65%. The FICA Tip is calculated based on the following:
Federal minimum wage amount: $1,087 (150 hours x $7.25 minimum wage)
Tips not eligible for the credit: $487 ($1,087 wage minimum - $600 wages paid)
Creditable tip amount: $413 ($900 tips - $487 tips not eligible)
FICA tip credit: $32 ($413 creditable tips x 7.65% tax rate)
It is important to note that in order to qualify as a “tip,” the customer cannot be required to pay it and must have the right to determine the amount. If the employer dictates the receipt or amount, such as a service charge applied to a bill and shared among multiple employees, the amount will generally not qualify for the credit.
It is also important to note that if the state minimum wage rate is higher than the federal minimum wage rate, the higher rate applies.
The information needed to calculate the credit should be readily available from the business’s payroll provider.
The credit can be claimed by filing Form 8846 (Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips) with the business’s annual income tax return.
For further information on this credit program, please contact Schneider Downs.
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