Full service restaurant owners with employees who receive tips from customers have an opportunity to claim a highly favorable federal tax credit on this year’s tax return. Restaurant owners can claim the “Credit for Employer Social Security and Medicare Taxes,” better known as the “FICA Tip Credit.” This tax credit is equal to the Social Security and Medicare taxes paid by an employer on certain employees’ tips earned working in a restaurant.
What is a tip?
According to Internal Revenue Service Revenue Ruling 2012-18, tips earned by servers in a restaurant are defined as:
As an employer, what am I required to do with the tips collected?
When tips or gratuities are collected, employers are required to distribute the funds directly to the employees who earned them. Tips that are distributed are considered compensation to the employee, requiring the employer to withhold 4.2% for Social Security taxes and 1.45% for Medicare taxes. The employer is also required to pay their share of the employment taxes, which is equal to 7.65% (6.2% Social Security and 1.45% Medicare) of the total compensation paid out to employees.
How is the tax credit calculated?
The employer’s share of the employment taxes on the tips disbursed to the employees would be the amount of the “FICA Tip Credit” the employer can claim on Tax Form 8846 ‘Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips.’
Café Burger is a sit-down restaurant where there are employees hired to serve food and beverages. In 2014, the restaurant collects $400,000 in gratuities that were distributed to the employees. The restaurant withholds both Social Security and Medicare Taxes from the employees’ gratuities distributed as compensation and pays their 7.65% (or $30,600) share of the employment taxes. Café Burger’s “FICA Tip Credit” is equal to the $30,600 that they paid on the employees’ tips.
However, if tipped employees are paid less than minimum wage designated for the tax credit, the credit is reduced by the employment taxes the employer would have paid on the difference. The IRS designates $5.15 as the minimum wage for the “FICA Tip Credit.”
Assume the same facts as Example 1 above, but also assume $100,000 of the $400,000 in gratuities distributed to the employees was used to meet the $5.15 minimum wage threshold. Only $300,000 of gratuities would be eligible for the “FICA Tip Credit” and the credit would be equal to $22,950 or 7.65% of employer Social Security and Medicare taxes withheld on $300,000 of gratuities.
Where does the tax credit go on my corporate tax return?
Restaurant owners who are incorporated as C-corporations would use the credit to directly reduce the tax liability on the face of the tax return. S-corporations and partnerships would pass the credit to its shareholders or members via their respective K-1 schedules. The shareholders or members would then claim their share of the tax credit on their personal income tax returns.
What types of payments do not qualify for the tax credit?
All restaurant owners wanting to claim the “FICA Tip Credit” should be aware that the following payments received by employees are not considered tips eligible for the tax credit:
Service charges are mandatory adds-ons to a food or beverage bill. An example of a service charge is an automatic 18% charge added the bill for parties of 8 or more. Effective beginning in 2014, Internal Revenue Service Revenue Ruling 2012-18 states that service charges received by a restaurant are deemed as business income to the restaurant as opposed to the employees. Any amounts distributed to the employees are treated as regular wages and are not eligible for the tip credit.
Aronson LLC is available for consultation on year-end tax planning and business management topics for restaurants. Please contact Aaron M. Boker, CPA at 240.364.2582 or firstname.lastname@example.org for more information.
Aaron Boker has written 12 post in this blog.
As a senior manager in Aronson LLC's Tax Services Group, Aaron Boker is a proactive advocate for his clients, which include restaurants, hotels, C corporations, S corporations, partnerships, individuals, trusts, and private foundations. In addition to his tax compliance and planning work, he is committed to building the firm's hospitality industry practice and has a deep understanding of the unique business issues faced by companies in this market. Aaron's clients benefit from his dedication to excellent service and his commitment to his work as part of a results-driven tax team committed to staying at the forefront of the profession.