How to Maximize the Benefits of the FICA Tip Credit for Businesses

Federal Taxes – some of the population’s least favorite words, both among business owners and employees. From the moment we earn our first paycheck, we are greeted by the omnipresent FICA deduction, a constant companion throughout our working lives.  

But if you are a business owner in an industry with tipped employees, the FICA Tip Credit is a tax break made just for you. Read on to better understand what it is, how it can help your business, and what to do if you’ve missed claiming it before.  

What is the FICA Tip Credit?

The Federal Insurance Contributions Act (FICA) is a federal law that mandates employers and employees to contribute toward Social Security and Medicare through payroll taxes. In industries that rely heavily on tipped employees, the FICA Tip Credit provides a way to balance these fiscal obligations. 

The FICA Tip Credit allows employers to claim a tax credit for the amount of FICA taxes they pay on employees' reported tips, under certain conditions. Introduced in 1993, the goal of the credit is to lighten the payroll tax burden for businesses that employ tipped workers, such as restaurants and bars.  

Essentially, the credit enables employers to reduce their federal income tax liability, acting as an incentive for accurate reporting of tips, which are often underreported. By accurately reporting tips, businesses stay compliant with the Internal Revenue Service (IRS) and can claim the FICA tip credit, thus lowering their tax liability. 

Who is eligible for the FICA Tip Credit?

To be eligible for the FICA tip credit, employers must meet several criteria: 

1. The business should be where tipping is customary, such as a restaurant, bar, or similar establishments. 

2. The tipped employees should be earning tips more than the federal minimum cash wage, currently at $2.13.  

3. Employers must pay their share of FICA taxes on the tips received by their employees. 

How to calculate the FICA Tip Credit 

The FICA tip credit is calculated based on the tips an employee receives over and above the federal minimum wage, excluding any amount the employer pays to meet the federal minimum wage requirement. The credit does not apply to the employer's share of FICA taxes paid on tips up to the amount used to meet the minimum wage requirements. 

Let's consider a real-world example to illustrate this: Suppose you run a restaurant with 30 employees. Each employee works 40 hours a week and earns $5 per hour in tips above the federal minimum wage. Thus, each employee's weekly tip income that qualifies for the FICA tip credit is $5/hour * 40 hours = $200. Over a year, this would be $200/week * 52 weeks = $10,400.  

For all 30 employees, this adds up to $10,400 * 30 = $312,000. The FICA tax rate, which combines Social Security tax (6.2%) and Medicare tax (1.45%), is 7.65%. Therefore, the total FICA tax paid on these tips is $312,000 * 7.65% = $23,868.  

This $23,868 is the FICA tip credit, which the restaurant can claim to offset its federal tax liability. 

The Significance of FICA Tip Credit 

The FICA tip credit is invaluable for businesses that employ tipped workers. It reduces a restaurant's federal tax liability and incentivizes correct tip reporting. This is a positive for employers & and employees, as well as the federal government, because it fosters transparency and fair business practices. 

What If I Haven’t Claimed the FICA Tip Credit in the past? 

If you just now recognize that this credit exists and qualify to take advantage of this opportunity, there’s good news! Not only can you claim the credit on your next filed income tax return, but you can also go back and amend your previously filed returns from up to 3 years ago. If you’re looking for some help with this process, chat with an expert on our team to get started.   

Paying out tips can be complicated in itself – after working with over 100 different restaurant groups, we GET it. For this reason, Whirks is dedicated to educating our restaurant clients about all the best practices we know when it comes to saving yourself time and money. Check out The 3 Biggest Mistakes Restaurants Make with Payroll or see if you still qualify for the Employee Retention Credit here. Ready to talk? So are we!