Tax Help - Employee FICA Tip Credit

Under IRS regulations, employers in the food and beverage industry may be eligible for a credit for social security and Medicare taxes paid on their employees' tip income.

To qualify for the credit, an employer must meet both of the following requirements:

• The employer must have employees who receive tips from customers for providing, delivering, or serving food or beverages for consumption if tipping os such employees is customary.
• The employer must have paid or incurred employment taxes (i.e. employer social security and Medicare taxes) on those tips.

The credit is equal to social security and Medicare taxes paid on qualifying employee tips. However, the credit may not be claimed on the portion of tips used to meet the federal minimum wage rate.

Sound confusing or complicated, well let me give you some examples:

• In 2006, an employer pays $3.75 an hour to an employee and applies $1.40 per hour in tips to meet the federal minimum wage rate of $5.15. In that case, employment taxes paid on the $1.40 per hour in tips cannot be used toward the credit.
• In 2006, an employer payd $4.90 per hour to an employee and applies $2.00 per hour in tips. Because only $0.25 ($5.15-$4.90) of the tips are applied to meet the federal minimum wage standard, employment taxes paid on the remaining $1.75 of tips are eligible for the credit.

The business deduction for employer social security and Medicare taxes paid must be reduced by the amount of any credit claimed. The credit is a general business credit and is claimed on Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips.

Under the recently enacted Small Business and Work Opportunity Tax Act, the credit is determined based on the federal minimum wage in effect on January 1, 2007 (i.e. $5.15). So, although the federal hourly minimum wage increased to $5.85 later in 2007, the credit is not reduced. Instead, the credit is computed as if the rate were still $5.15 per hour.

• In 2007, an employer pays $3.75 per hour to an employee and applies $2.10 per hour in tips to meet the new federal minimum wage rate of $5.85. In this situation, the employment taxes paid on $0.70 per hour in tips will be eligible for the credit ($5.85-$5.15). Thus, the credit limitation has been frozen at the previous federal minimum wage rate of $5.15 per hour.

Another provision of the new law allows the credit to offset the alternative minimum tax. Before the change, the credit could not reduce federal income tax liability below tentative AMT.

Additional resources:

Frequently Asked Questions - Allocated Tips

Restaurant Tax Tips

Tip Income