FICA Tip Credit: How to Cut Payroll Taxes on Tips

Paying payroll taxes on your team's tips feels like getting taxed twice. You're already covering FICA on their wages, and now you're paying the employer share on every tip they report. For restaurants, bars, and salons, that adds up to thousands of dollars a year.

The FICA Tip Credit exists to give you some of that money back. It's an IRS tax break that lets you recover part of the employer portion of Social Security and Medicare taxes you pay on reported tips. Most small business owners don't know about it, which means they're leaving real money on the table.

This guide breaks down who qualifies, how to calculate your savings, and the exact steps to claim it.

FICA Tip Credit: What you need to know.

The FICA Tip Credit is an IRS tax break that helps restaurants, bars, salons, and other hospitality businesses recover part of the employer portion of Social Security and Medicare taxes paid on reported tips.

Here's what matters:

• Who qualifies: Businesses where employees regularly serve food or beverages and earn at least $20/month in tips
• What's covered: Only tips that bring wages above federal minimum wage count toward the credit
• How much you save: You can claim 7.65% of eligible tip income as a credit on your business taxes
• How to claim it: File IRS Form 8846 with your annual tax return, and keep accurate tip records throughout the year
• Retroactive claims: You can amend past returns to capture missed credits, typically up to three years back

Most small business owners miss out on this credit simply because they don't know it exists. With the right tip tracking and payroll tools, claiming it becomes straightforward instead of a paperwork nightmare.

What is the FICA tip credit?

The FICA Tip Credit is a federal tax break that helps employers recover some of the Social Security and Medicare taxes they pay on employee tips. If your team reports tips as part of their income, you're paying the employer portion of FICA taxes on those tips. This credit lets you get some of that money back.

FICA stands for the Federal Insurance Contributions Act. It's the tax that funds Social Security and Medicare. Both you and your employees pay into it. Your team pays 7.65% of their wages (including tips), and you match that with another 7.65% as the employer. That's where the cost adds up fast. 

The IRS created the FICA Tip Credit to encourage accurate tip reporting. When employees report their tips correctly, you pay more in payroll taxes. The credit offsets that cost, so you're not penalized for following the rules.

The difference between FICA taxes and the FICA credit

FICA taxes are what you and your employees pay on all wages, including tips. It's a mandatory payroll tax that funds Social Security (6.2%) and Medicare (1.45%). Combined, that's 7.65% from the employee and 7.65% from you as the employer.

The FICA Tip Credit specifically targets the employer portion you pay on tips that exceed the federal minimum wage. You still pay the full FICA tax upfront when you run payroll. The credit comes later when you file your business taxes. Think of it as a rebate for doing the right thing and properly reporting tip income.

Which businesses qualify for the FICA tip credit?

Not every business with tipped employees can claim the FICA Tip Credit. The IRS has specific requirements you need to meet before you're eligible.

Food and beverage service businesses

Your business must provide, deliver, or serve food or beverages to customers. This includes restaurants, bars, cafés, catering companies, food trucks, and similar operations where tipping is customary. The key is that your employees are directly involved in serving food or drinks as part of their regular duties.

Hair salons, spas, and other service businesses with tipped employees don't qualify for this specific credit, even though their teams earn tips. The credit only applies to food and beverage operations.

Employees must receive at least $20/month in tips

Your employees need to report at least $20 in tips per month to be counted toward the credit. This is the same threshold that triggers tip reporting requirements under federal law. If an employee earns less than $20 in tips during any month, those tips don't count toward your credit calculation for that period.

Meeting federal minimum wage

Here's where it gets specific. You can only claim the credit on tips that bring your employee's total pay above the federal minimum wage of $7.25 per hour. If you're using tips to meet minimum wage requirements (also called taking a tip credit), those tips aren't eligible for the FICA Tip Credit.

Let's say you pay a server $5 per hour in direct wages. Tips bring their total pay up to $7.25 per hour to meet minimum wage. You can't claim the FICA Tip Credit on those first $2.25 per hour in tips. But any tips they earn beyond that threshold do qualify for the credit.

Even if you pay above minimum wage, the calculation still uses $7.25 as the baseline. Only reported tips that exceed what would be needed to reach $7.25 per hour count toward your credit.

How to calculate your FICA tip credit (with example)

The math behind the FICA Tip Credit is straightforward once you understand the formula. You're claiming 7.65% of eligible tip income as a credit against your business taxes.

Step-by-step calculation process

Here's how to calculate your credit:

• Step 1: Gather total reported tips. Collect all the tips your employees reported to you during the tax year. This includes cash tips, credit card tips, and any tips distributed through pooling arrangements.
• Step 2: Subtract tips used to meet minimum wage. For each employee, calculate how many tips were needed to bring their wages up to $7.25 per hour. These tips don't count toward the credit. Only the excess tips above that threshold are eligible.
• Step 3: Multiply excess tips by 7.65%. Take the eligible tips and multiply by 7.65%, which represents the employer portion of Social Security (6.2%) and Medicare (1.45%) taxes.
• Step 4: That's your credit amount. The result is the dollar amount you can claim as a credit on your business tax return.

Real-world example

Let's walk through a complete example to see how this works in practice.

A server works 100 hours in a month and earns $5.85 per hour in direct wages from you. They report $450 in tips for the month.

• Calculate total wages: $5.85 per hour × 100 hours = $585
• Calculate minimum wage threshold: $7.25 per hour × 100 hours = $725
• Determine tips needed to reach minimum wage: $725 (minimum wage total) - $585 (wages paid) = $140 in tips needed
• Calculate excess tips eligible for credit: $450 (total tips) - $140 (tips to reach minimum) = $310 in eligible tips
• Calculate your FICA Tip Credit: $310 × 7.65% = $23.72

In this example, you can claim $23.72 as a credit for this one employee for one month. Multiply that across all your tipped employees for the entire year, and the savings add up quickly.

Keep in mind that if your employee earns above the Social Security wage base (which changes annually), the calculation adjusts slightly since you only pay Medicare tax on those excess wages.

How to claim the FICA tip credit in 3 steps

Claiming the credit requires accurate records and the right forms. Here's exactly what you need to do.

Step 1: Confirm eligibility and payroll compliance

Before you claim anything, verify that your business meets all the requirements. You need to operate a food or beverage business where tipping is customary, and your employees must receive tips for providing, delivering, or serving food or beverages.

Make sure your payroll records are accurate and complete. You'll need documentation showing the wages you paid, the tips your employees reported, and the FICA taxes you paid on those tips. This isn't optional. Without proper records, the IRS can deny your credit entirely.

Step 2: Keep accurate records for IRS

The IRS requires detailed documentation of all tip income your employees reported. This means maintaining records of individual employee tip reports, total hours worked, hourly wages paid, and FICA taxes withheld and paid.

Store these records securely and keep them accessible for at least three years. If you're audited, you'll need to produce documentation showing exactly how you calculated your credit. Monthly tip reports, timesheets, and payroll records should all be organized by employee and by tax period.

Tools that automate tip tracking and integrate with your payroll system make this process significantly easier. When tips are automatically recorded and calculated through your payroll software, you eliminate manual errors and create the audit trail the IRS expects.

Step 3: File Form 8846

To actually claim the credit, you'll complete IRS Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips. This form attaches to your annual business tax return.

The form walks you through the calculation we covered earlier. You'll report total tips received, subtract tips used to meet minimum wage, and calculate the credit based on the eligible amount.

File Form 8846 with your business tax return by the normal filing deadline. If you're filing as a corporation, that's Form 1120. Partnerships use Form 1065. The credit flows through as part of your general business credit.

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Can you claim the FICA tip credit retroactively?

Yes. If you missed claiming the credit in previous years, you can file an amended tax return to capture those credits. Many businesses don't realize they're eligible until years after the fact, which means they've left money on the table.

The IRS generally allows you to amend returns for up to three years from the original filing date. So if you filed your 2023 return in April 2024, you have until April 2027 to amend it and claim the FICA Tip Credit for that year.

To claim retroactive credits, you'll need to gather all the same documentation we discussed earlier. Pull your payroll records, tip reports, and FICA tax payments for each year you want to amend. Then complete Form 8846 for each tax year and attach it to an amended business tax return.

If you also need to adjust your quarterly payroll tax filings, you may need to file Form 941-X (Adjusted Employer's Quarterly Federal Tax Return) alongside your amended annual return. This corrects any discrepancies between what you reported quarterly and what you're now claiming annually.

The process takes time, but the potential savings make it worthwhile. If you've been operating for several years without claiming this credit, you could be looking at thousands of dollars in retroactive credits.

Common mistakes that cost businesses their credit

Even businesses that qualify for the FICA Tip Credit can lose out if they make these common errors.

• Not separating tips from service charges. The IRS treats service charges differently from tips. If you automatically add an 18% gratuity to large party bills, that's a service charge, not a tip. Service charges are regular wages and don't qualify for the credit. Only voluntary tips from customers count. Make sure your payroll system clearly distinguishes between the two.
• Failing to track cash tips. Cash tips are just as eligible for the credit as credit card tips, but only if your employees report them properly. Many businesses lose out on credits because cash tips go unreported or under-reported. Implement a consistent system for employees to report all cash tips, and make sure they understand that accurate reporting benefits everyone.
• Underreporting or missing records. Without complete documentation, you can't claim the credit. If you don't have records showing exactly what each employee earned in tips, how many hours they worked, and what wages you paid, the IRS will deny your claim. Missing even one element of the required documentation can disqualify your entire credit for that period.
• Not using payroll tools that track tip wages accurately. Manual tip tracking leads to errors. When you're calculating credits across multiple employees over an entire year, even small mistakes multiply quickly. Payroll systems that automatically track tips, calculate eligible amounts, and generate the reports you need for Form 8846 eliminate the risk of calculation errors that could cost you the credit.

FAQs about the FICA tip credit

Am I eligible for FICA refund?

You're eligible for the FICA Tip Credit if you operate a food or beverage business where employees receive tips for serving customers. Your employees must report at least $20 in tips per month, and you must pay FICA taxes on those tips. The credit applies only to tips that bring employee pay above $7.25 per hour. You claim this as a tax credit on your business return using Form 8846, not as a refund. If you paid FICA taxes on eligible tips in previous years, you can amend past returns to claim missed credits.

Is FICA your credit score?

No. FICA has nothing to do with your credit score. FICA stands for the Federal Insurance Contributions Act, which is the payroll tax that funds Social Security and Medicare. Both employees and employers pay FICA taxes on wages and tips. The FICA Tip Credit is a tax break for employers that lets them recover some of the FICA taxes they pay on employee tips. Your credit score relates to your borrowing history and has no connection to FICA taxes or the FICA Tip Credit.

What does FICA mean on your paycheck?

FICA on your paycheck represents the Social Security and Medicare taxes withheld from your wages. Employees pay 7.65% of their earnings (6.2% for Social Security and 1.45% for Medicare), and employers match that amount. If you're a tipped employee, FICA is calculated on both your hourly wages and your reported tips. This withholding funds your future Social Security retirement benefits and Medicare coverage. Your employer is responsible for sending both your portion and their matching portion to the IRS.

What is a credit to the FICA taxes payable account?

A credit to FICA taxes payable reduces what your business owes in payroll taxes. The FICA Tip Credit specifically reduces your business income tax liability by the amount you paid in employer FICA taxes on eligible tips. It's not a direct credit to your payroll tax account. Instead, you claim it on your annual business tax return using Form 8846, and it reduces your overall tax bill. This is a non-refundable credit, meaning it can reduce your taxes owed to zero but won't generate a cash refund beyond that.

How Homebase helps you maximize your FICA tip credit

Tracking tips and calculating your credit shouldn't be complicated. Homebase automates the entire process so you can capture every dollar you're entitled to without the paperwork headaches.

Our Tip Manager tracks all tip income automatically, whether it's cash, credit card, or pooled tips. Everything flows directly into payroll, creating the accurate records the IRS requires for Form 8846. No more manual spreadsheets or wondering if your calculations are correct.

When it's time to run payroll, Homebase calculates FICA taxes on both wages and tips, then generates the reports you need to claim your credit. One-click exports give you everything required for your tax filing.

Ready to stop leaving money on the table? Try Homebase free and see how easy it is to manage tips, run payroll, and maximize your tax credits all in one place.

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