If you run a restaurant that handles tips, you know that it can sometimes be tricky to keep track of everything. You’ve got to deal with cash tips, charged tips, tip credit, minimum wage laws, tip reporting, and more.
All of these things can add up to a lot of work and headache, especially when you factor in the tax implications.
If you’ve been in the business for a while, you know that it can be tricky to keep up with all of these rules.
But the good news is, once you understand some of the key terms related to tips, you can better prepare to handle them at your business and keep you and your employees compliant.
One of the more important ones to understand is “FICA tip credits,” which is something that every business owner should be aware of.
This is a complicated one, so we’ll take it slow and hopefully help you understand exactly what it is and how to handle it.
What is the FICA Tip Credit?
The FICA Tip Credit is a tax credit that allows businesses to take credit for a portion of Employer Social Security Paid on Cash Tips that are paid to an employee.
In the simplest of terms, it’s a way for employers to legally take credit for Social Security and Medicare taxes that are already being paid on employees’ tips.
The credit is designed to help small businesses handle these taxes on tips, which can add up quickly when taxes aren’t taken care of.
The FICA Tip Credit is only available for businesses in food and beverage industries with tipped employees who serve food or drink.
If you’re not sure your business qualifies, check with the IRS.
As an employer, you pay FICA taxes on your employees’ wages, including tips. With this credit, you can get some money back on the amount of FICA taxes. The IRS implemented the FICA Tip Credit to ensure that businesses are accurately reporting their employees’ tips and earnings to the government.
How Do FICA Taxes Work with Tipped Employees?
When a customer gives a tip to their server, bartender, or other tipped employee, it’s also considered as income (tip income).
Therefore, income tax must be paid just like for any other earnings (like hourly wages).
When it comes to paying, FICA taxes are paid by both employees and employers on gross wages. Gross wages include tips, so FICA taxes are owed on tips, too. Because of that, it is important that tips get reported correctly and input into payroll so that FICA taxes (and all other payroll taxes) are withheld correctly.
FICA Taxes
FICA includes two taxes: Social Security and Medicare. Both employers and employees pay FICA taxes on wages. The total rate for Social Security is 12.4%, meaning employers and employees pay 6.2% each. The total rate for Medicare is 2.9%, meaning employers and employees pay 1.45% each.
Cash Tips
Some employees make cash tips, which are tips that they receive immediately (during or after their shift) in cash. This can include charged tips if you cash them out and give them to the employee as part of their cash tips. These are different from paycheck tips, which are tips that you pay out via payroll.
Regardless of whether an employee receives cash tips or gets paid through their employer, the rules are the same. The total amount of tips that they receive (cash + charged tips) is considered gross income and must be paid to the IRS.
Cash tips can be a little tricky to handle because it is important that employees accurately report the cash tips they make so they can be entered into the payroll. Although the employees already have the cash in hand, they (and their employer) must pay taxes on it via payroll.
Qualifying for The FICA Tip Tax Credit
To be eligible for the credit, aside from being in the food or beverage industry, business owners (restaurant owners, bar owners, etc) must make sure that employees are compensated at least the federal minimum wage for all hours worked. If your business is in a state with a higher minimum wage, then employees’ wages must meet that standard.
Total compensation may include hourly wages, tips, service charges, lodging, and meals provided by the business.
How to Handle FICA Tip Credit
First things first, it’s essential that you and your employees report tips and all forms of compensation correctly.(Tips are reported on their individual income tax return)
That is the foundation of the reporting you will need to claim the FICA Tip Credit.
If your employees made above the federal minimum wage, you may be eligible for the FICA Tip Credit. The IRS explains, “Generally, the tax credit equals the amount of employer social security and Medicare taxes paid or incurred by the employer on tips received by the employee.
However, employers cannot claim the credit for taxes on any tips that are used to meet the federal minimum wage rate.” To claim the tip credit, you must fill out and file IRS Form 8846 with your business tax returns. Follow the instructions on the form to make sure you qualify and fill it out correctly.
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FICA Tip Credit FAQs
What is FICA?
FICA (Federal Insurance Contributions Act) is a provision of the Fair Labor Standards Act (FLSA) that requires both employers and employees to pay taxes in order to fund Social Security and Medicare.
Do Tips Count as Wages?
Yes, reported tips are considered as gross income and must be included in an employee’s wages for purposes of FICA tax. In addition, they are subject to federal income tax withholding.
What is the Credit Rate for FICA?
The credit rate for FICA is 7.65%, 6.2% for Social Security, and 1.45% for Medicare.
Who is Eligible for FICA Tax Credit?
Employers in the food and beverage industry are eligible for FICA tax credit. Additionally, their employees must be paid at least the federal minimum wage.
What Is the Purpose of the FICA Tip Credit?
The IRS introduced the FICA Tip Credit to promote accurate reporting of tip income and earnings by businesses, facilitating proper tax and earnings documentation.
Do Tips Count as Wages for the Purpose of the FICA Tip Credit?
Indeed, tips are treated as wages under the FICA Tip Credit. Employees must accurately record all tips, whether cash or credit, for income tax, Social Security, and other deductions.
What Is the Role of the Employer in the FICA Tip Credit?
Employers are tasked with ensuring the accurate reporting of tips by their employees. They are required to verify and collect this information as needed.
What Happens If Employees Earn More Than the Federal Minimum Wage?
Employers whose employees earn above the federal minimum wage may qualify for the FICA Tip Credit.
What Is the Basis for Calculating the FICA Tip Credit?
The FICA Tip Credit calculation is based on the federal minimum wage set at $5.15 per hour, a figure established by the Small Business and Work Opportunity Tax Act of 2007.
What Is the Formal Name of the FICA Tip Credit?
The official designation of the FICA Tip Credit is “Credit for Portion of Employer Social Security Paid with Respect to Employee Cash Tips.”
Does the FICA Tip Credit Apply to Medicare Taxes?
The FICA Tip Credit does apply to Medicare taxes, allowing employers a credit against their federal income tax for the FICA and Medicare taxes paid on reported tips.
Is the FICA Tip Credit Refundable?
The FICA Tip Credit is not refundable. Unused credits can be carried back for one year or carried forward for up to 20 years.
Can the FICA Tip Credit Be Used to Offset Alternative Minimum Tax?
The FICA Tip Credit can offset the alternative minimum tax for taxable clubs using a significant portion of their net operating loss in a given year.
Who Qualifies for the FICA Tip Credit in a Club Setting?
In clubs, the FICA Tip Credit applies solely to food and beverage employees, as defined by the IRS as those receiving tips for providing, delivering, or serving food or beverages.
Is the FICA Tip Credit Available for Both Taxable and Exempt Clubs?
The FICA Tip Credit is accessible to both taxable and exempt clubs.
What Is the Impact of the FICA Tip Credit on a Club’s Taxable Income?
The FICA Tip Credit can significantly reduce a club’s taxable income, especially for clubs with extensive food and beverage operations.
Remember: This is not legal advice. If you have questions about your particular situation, please consult a lawyer, CPA, or other appropriate professional advisor or agency.
