As a small business, you need all of the tax breaks you can get to boost your bottom line. If you’re a company that hires tipped workers, you may be able to spend less on your taxes by taking advantage of the Federal Insurance Contributions Act (FICA) tip credit. However, there are a few important rules about which FICA payments are eligible, so it’s a good idea to consult with your accountant or payroll expert before claiming this credit.
What Is the FICA Tip Credit?
Normally, employers pay a 7.65% FICA tax on their employees’ wages. Out of this amount, 6.2% is for Social Security taxes, and 1.45% is for Medicare taxes.
On top of the normal FICA taxes on wages, you are also expected to pay FICA taxes on the employee’s tips. Any worker who earns at least $20 in tips a month must report their tip earnings to their employer. Even though you don’t have control over how much the employee may make in tips, you are obligated to submit 7.65% in FICA taxes to the government as their employer. Similarly, you must withhold 7.65% of the employee’s paycheck to send in for employee FICA taxes.
Originally, the FICA tip credit was enacted in 1993 with the goal of increasing income and employment tax compliance. With this objective in mind, it was intentionally designed to be a generous credit for employers. While you can’t get a credit for taxes paid on the first $5.15 in earnings per hour, you can get a credit for any FICA taxes you paid for tips earned past the $5.15 mark.
How Does the FICA Tip Credit Work?
To claim the FICA tip credit, you must turn in Form 8846 when you do your taxes. For the purpose of the FICA tip credit, the minimum wage for tipped workers is $5.15 an hour. Legally, you must pay your worker $2.13 per hour. Then, tips can make up the difference between $2.13 and the federal minimum wage of $7.25 per hour. It’s important to remember that the minimum wage used for FICA calculations is $5.15 an hour, not $7.25.
While tip credits reduce the amount you have to pay in taxes when you file your return, you still have to pay FICA taxes during the year as your employees earn tips. However, you can get some of these payments back at tax time, reducing your company’s tax obligation.
How To Calculate the FICA Tip Credit
To calculate the FICA tip credit, you first must compile all of your payroll information and FICA tax payments. At Asure, we provide you with all of the information you and your CPA need to fill out Form 8846 and receive the tip credit, ensuring a simple, convenient tax filing process.
Here’s an example of how calculating the tip credit typically works.
- Combine tips and earnings: An employee is paid $2.13 for 30 hours of work, which works out to $63.90. They received $400 in tips, so their total earnings are $463.90. Because they earned more than the federal minimum wage of $7.25 per hour, the employer doesn’t have to pay them any extra wages.
- Calculate the FICA minimum wage: Because the FICA minimum wage is $5.15 per hour, the employer has to pay FICA taxes on just $154.50 because $5.15 x 30 = $154.50.
- Determine the tax credit: These figures are used to calculate the tax credit. Subtract the FICA wages that had to be paid ($154.50) from the actual earnings ($463.90) to get ($309.40). Now, multiply $309.40 by the FICA tax of 7.65% to get $23.67.
In this example, the employer is eligible for a FICA tax credit of $23.67 for that employee. Assuming the employee earned the exact same all year long, this would work out to a credit worth $1,230.84 per year. If you have many different employees receiving tips, this credit can quickly add up to a substantial amount.
When Does the FICA Tip Credit Apply?
The FICA tip credit is likely available to your business if the following situations apply.
- You run a food or beverage company where employees typically receive tips.
- Employees at your company received tips for providing, delivering, or serving beverages and food.
- You paid FICA taxes on your workers’ tips.
As long as these situations apply, you can claim the FICA tip credit on your tax return. Even if your employee doesn’t report those tips on their tax return, you’re still eligible for the credit.
Which Companies Qualify for the Tip Tax Credit?
Your small business is only eligible for the FICA tip tax credit if you are a food and beverage company. Previously, the federal tip tax was only available if the employee spent at least 80% of their time in tip-producing activities. The 80/20 rule was struck down by the Fifth Circuit Court of Appeals in 2024, removing it as a criterion for businesses.
Remember: State Laws Can Vary
No matter what state you live in, you can use the FICA tip tax credit. However, there are state-by-state differences in other tip-related laws that you must be aware of. In many states, the amount you must pay tipped workers is higher than the federal minimum.
For instance, California doesn’t allow employers to pay less than the state’s minimum wage by counting tips as income. In New York, $5.50 of the employee’s minimum wage earnings per hour can come from tips. This means that the employee can be paid $11 an hour as long as they receive at least $5.50 in tips.
Simplify FICA Tip Credits by Working with Your Payroll Provider
When you work with a top payroll provider like Asure, you don’t have to handle all of the wage calculations on your own. At the end of the year, we gather all of the information your CPA will need to apply for your FICA tip credit. On average, we estimate that this step saves companies about four hours of labor.
Learn More About Claiming the FICA Tip Credit
If you are a food and beverage business, the FICA tip credit can help you save hundreds or thousands of dollars per year on your business tax return. Asure makes calculating tipped wages and FICA taxes easier by providing you with all of the information you need to file for your tip credit each year. With the help of an experienced payroll provider, you can navigate the intricacies of Form 8846 and enjoy important tax advantages.
To learn more about FICA tip credits, reach out to our team of small business payroll and HR experts today.