Between ordering and managing inventory, hiring and training new employees, and monitoring the quality of food, drink, and service, restaurant owners have very demanding jobs. Adding to that demand is the need to maintain accurate financial records and navigate the intricacies of restaurant payroll and taxes, which can be complicated because employees’ paychecks may include several different forms of compensation, each with different tax treatments. Among them: regular hourly wages, tips and gratuities, service charges, banquet tips, and meals.
Restaurant employers are required to pay taxes on the tips their employees collect from patrons, as the tips are considered income under the Federal Insurance Contribution Act (FICA). But what many restaurant employers don't know is that there's an incentive to accurately reporting their workers’ tip earnings: an income tax credit called the FICA tip credit, which can potentially save restaurants hundreds of dollars per employee. In order to claim the FICA tip credit, employers and employees each have several responsibilities.
Restaurant employers are responsible for ensuring their non-exempt employees earn at least the federal minimum wage for all hours worked. Some states have a higher minimum wage than the federal, in which case covered employees must be paid the higher wage. The minimum wage requirement may include different forms of compensation, including hourly wages, meals furnished for the benefit of the employee, and tips recorded by the restaurant worker.
In order to take advantage of the FICA tip credit, restaurant owners must request this tax credit on their business tax returns. The FICA tip credit is applied to IRS Form 8846, also referred to as the Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips.
Employees are responsible for accurately recording daily tips, both cash and credit, and providing the total to their employer in writing. This total is used toward income tax, social security, and Medicare withholdings. For more information on withholding and reporting, visit the IRS website.
Calculating the FICA Tip Credit
The Fair Labor Standards Act (FLSA) allows restaurant employers to include the tips their employees earn toward meeting the minimum wage requirements. If the amount of tips exceeds the federal minimum requirement, restaurant employers may be eligible for a partial tax credit. This credit equals the employer's portion of the FICA tax, which is currently 7.65 percent, multiplied by the tips in excess of the federal minimum wage.
Here's an example:
Sarah works at a restaurant downtown. She earns $2.13 an hour, works 30 hours a week, and reports $250 in tips in a given week. Although the Federal Minimum Wage has since been raised to $7.25 an hour, due to the Small Business and Work Opportunity Tax Act of 2007, the FICA tip credit will continue to be based on the old minimum wage of $5.15 an hour.
First we'll determine Sarah's weekly wages by multiplying her hourly wage ($2.13 an hour) by 30 hours worked. This totals $63.90. Add in the weekly reported tips of $250.00, and we have $313.90. Next we'll calculate the wages paid at minimum wage by multiplying $5.15 (the minimum hourly wage rate used for the purpose of calculating the FICA Tip Credit) by 30 hours worked, which equals $154.50. Subtract the first value ($313.90) by the second value ($154.50) to find the amount of tips in excess of minimum wage, which is $159.40. Multiply that by 7.65 percent (the employer's portion of the FICA tax) to determine the tax credit. We end up with $12.19. While that doesn't seem like a lot of money, if Sarah consistently works the same amount of hours earning the same amount of tips for 52 weeks, the potential annual savings could be $633.88. And that's just one employee!
We're Here to Help
While you can use the equation above to determine how much you can save with the FICA tip credit, you can also use our FICA Tip Tax Savings Calculator. Restaurant owners can easily plug in their information and calculate their savings fast and accurately. No matter how complex restaurant payroll can be, the specialists at Paychex are here to help you through every step of the process.