Employers are legally required to pay the Federal Insurance Contributions Act (FICA) on employee wages and tips. Fortunately, the FICA tip credit can help you decrease your company’s tax burden. By carefully tracking wages throughout the year, you can help your business save a significant amount of money.

What Is the FICA Tip Tax? 

If employees earn at least $20 in tips each month, they are legally required to report their tips. This matters because employers must remit FICA taxes for the employee and employer portions of FICA. 

Fortunately, the FICA tip tax credit can help you reduce your tax obligation. This tax credit uses the amount you paid in FICA tip to lower the amount you have to pay in business taxes. When the FICA tip tax credit was implemented in 1993, it was designed to increase tax compliance among tipped employees and employers by giving employers a huge tax break on FICA taxes.  

To calculate the credit you can get, you must subtract the employee’s non-tip wage from $5.15 an hour. The difference between $5.15 and the employee’s wage is still charged FICA taxes. Afterward, you get a FICA tip tax credit from any earnings that are made past the $5.15 amount.     

Basically, you are getting a credit on all the tips that are paid after the employee makes $5.15 an hour. Until they reach the $5.15 mark, you are expected to pay FICA taxes for your employees. 

This credit is non-refundable, so you can only get back the money you owe in taxes. However, it does include carryback and carryforward provisions. You can use the carryback provision for the previous year, or the carryforward rule will let you use any extra credits on your tax returns for up to 20 years.

How to Reduce Your Tax Obligation With the FICA Tip Tax Credit 

Through the FICA tip tax credit, you can potentially lower your tax bill and improve your bottom line. There are nearly 15 million food service workers in the United States, so there are many people who receive tips and are covered by this credit. As an employer, there are a few important steps you need to take to reduce payroll tax costs for your tipped employees.  

1. The Employee Reports Their Tips

If an employee earns more than $20 in a month, they are legally required to report their tips to their employer. It’s important to get your employees to report their tips. If they don’t, they may be subject to a penalty worth 50% of the taxes they owe.

Is there a penalty for not reporting tips as an employer? Because the Internal Revenue Service (IRS) holds employers responsible for reporting tips, there are a range of consequences if you don’t report employee tips properly. You may be charged a penalty, back taxes, and interest. In extreme cases, criminal charges can even be filed, so it’s important to report tips as accurately as possible.   

2. You Remit FICA Taxes on Employee Wages 

Once you have reported the amount earned in tips, you must calculate and remit FICA taxes on these wages. You and the employee must each pay 6.2% for Social Security taxes and 1.45% in Medicare taxes.  

Remember the 80/20 Rule 

The 80/20 rule is important for tipped workers because it determines if you can get the tip credit or not. According to the rule, the employee must spend 80% of their time doing tipped activities. Then, 20% of their time can be devoted to activities that don’t generate tips, such as preparing silverware or clearing tables. 

This rule is in place so that tipped employees have plenty of opportunities to earn a minimum wage through tipped work. While this might not be a problem in states where employees make the same minimum wage as other employees, some states let employees earn the tipped minimum wage instead. Currently, the federal minimum wage is $7.25 per hour, but the tipped minimum wage is $2.13 per hour. 

Examples of FICA Tip Credit Calculations

Your CPA or tax preparation software will typically calculate this credit for you. To get a feel for what manual FICA tip tax credit calculations look like, check out the following examples. 

Example 1:

Sandra worked 125 hours at Alphabet Diner for $2.15 an hour. Her gross monthly earnings were $268.75 She earned an additional $450 from tips. 

Earnings: $268.75

Federal Minimum Earnings (125 hours x $515): $643.75

Tips Ineligible for Credit ($643.75 federal minimum – $268.75 earnings): $375  

Tips Eligible for the Credit ($450 tips – $375 ineligible tips): $75

Total Credit ($75 x 7.65%): $5.63

Example 2:

Peter worked 160 hours at $4 an hour. His gross monthly earnings were $640. He earned an extra $800 in tips. 

Earnings: $640

Federal Minimum Earnings (160 hours x $5.15): $824

Tips Ineligible for Credit ($824 federal minimum – $640 earnings): $184  

Tips Eligible for the Credit ($800 tips – $184 ineligible tips): $616

Total Credit ($616 x 7.65%): $47.12

Example 3:

Jennifer worked 100 hours at $12 an hour. Her gross monthly earnings were $1,200. She earned an additional $1,000 in tips. 

Earnings: $1,200

Federal Minimum Earnings (100 hours x $5.15): $515

Tips Ineligible for Credit ($515 federal minimum – $1,200 earnings): (None because her wages exceed the federal minimum) 

Tips Eligible for the Credit ($1,000 tips – $0 ineligible tips): $1,000

Total Credit ($1,000 x 7.65%): $76.50

3. You Claim a FICA Tip Credit 

In order to claim the FICA tip credit, you must carefully track the employee’s tips and earnings throughout the year. Then, you can use this information to claim a FICA tip credit when you file your taxes for the year. 

Form 8846 is turned in with the rest of your tax forms. If the amount you claim is more than the amount you owe, you can carry the credit back a year or forward up to 20 years.

Things to Remember When Calculating FICA Tip Credits 

As you track your FICA tip credit, there are a few important things you should keep in mind.

• This credit is only available to employers in the food and beverage industry with employees who serve food and drinks. 
• You still have to withhold the employee’s FICA contribution because this credit doesn’t impact their contribution level. 
• While the federal minimum wage has changed to $7.25, the minimum wage used in the tip credit is still at the former minimum wage of $5.15. Fortunately, this is good for business owners because it allows you to start accruing the tax credit earlier.
• Cash tips must still be reported to the IRS like tips that are run on credit card machines. This can be challenging for employers because you are often relying on employees to give you an accurate figure for their cash tips.
• The IRS assumes that employers have underreported tips if the organization’s tips are less than 8% of their gross receipts. 
• If you serve meals on your premises and have at least 10 servers a day, you are required to report to the IRS the amount of tips your employees report to you.

Discover More Tax Credits for Your Small Business 

Through the FICA tip credit, you can reduce the amount of taxes you have to pay on employee tips. While you still have to pay FICA for up to the minimum wage amount listed in the tip credit, you can get a credit for any FICA tax that is paid after that amount. 

If you are interested in lowering your tax burden and learning about the FICA tip credit, we can help. Reach out to our team of small business HR and payroll experts today.