There is a tax credit available to restaurants that have tipped employees. The credit is based on the FICA taxes paid by the restaurant on reported tips. Although this credit has been available to restaurants for years, many tax professionals fail to inform their clients that the credit is available. If you’re a restaurant owner, keep reading.
Restaurants must pay FICA taxes on any tips reported by tipped employees. This requirement has been criticized by the restaurant industry since 1987 because reported tips in excess of the minimum wage are not counted as wages under the Fair Labor Standards Act (FLSA). Since tips in excess of minimum wage are not counted as wages under the FLSA, it is argued that it is not appropriate to require restaurants to pay FICA taxes on these tips.
As a result of lobbying by the restaurant industry, Congress created a tax credit in 1993 to offset some of the FICA taxes paid by restaurants on excess tips (tips that get the employee over minimum wage). The credit is named the Credit for Portion of Employer Social Security Paid with Respect to Employee Cash Tips. They tried, but couldn’t come up with a longer name.
How it Works
The credit is calculated as 7.65% of tips in excess of the federal minimum wage. For purposes of this tax credit, the federal minimum wage is capped at $5.15, and not at the normal $7.25 federal minimum wage. Michigan’s minimum wage of $7.40 is not relevant to this credit; however, under Michigan law the employee’s base wage plus tips must be at least $7.40.
Example: JoJo’s Restaurant has a tipped employee who earns $2.65 per hour. The employee worked 1,500 hours during 2012 and had tips of $8,000.
The tip tax credit is calculated as follows:
Hourly Tip Rate: $5.33 ($8,000 tips divided by 1,500 hours)
Tips Deemed Wages: $2.50 ($5.15 federal minimum wage less $2.65 wage)
Excess Tips per Hour: $2.83 ($5.33 total tips less $2.50 tips treated as wages)
Total Excess Tips: $4,245 ($2.83 excess tips per hour times 1,500 hours worked)
Tip Tax Credit $325 ($4,245 times 7.65% FICA rate)
The tip tax credit for this single employee is $325.
The tip tax credit is calculated for each individual employee. Modern payroll software makes it much easier to determine how much of each employee’s tips are deemed wages and how much are excess tips.
There has been some confusion as to whether restaurant owners could claim the credit on unreported tips discovered during an IRS audit. The answer is yes—restaurant owners can claim the tip tax credit on unreported tips discovered during an audit (good news if you’re looking for a silver lining during an audit.)
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Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.
Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230