Part II by Jason Meersman
Last week we touched on many of the complicated obstacles of being a restaurant owner. This week, we provide some relief - with a tax credit that can save thousands each year and that many employers may not know they are due.
Amidst all of the controversy regarding fair wages and the tip vs. no-tip policy, lies a tax credit that works to the restaurant owner’s advantage. It’s called the FICA Tip Credit, formerly known as the “Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips.”
Here’s how it breaks down:
By law, employers are required to track, record, and pay taxes on gratuities that their employees receive from dining patrons. These tips, under the Federal Insurance Contribution Act (FICA), are defined as taxable income. Keeping track of and managing these accurately can be a complicated process for everyone involved.
According to the IRS Ruling 2012-18, tips are defined as payments that:
- Are made free from compulsion
- The customer has unrestricted rights to determine the amount of
- Are not subject to negotiation or dictated by employer policy
- The customer has the right to determine who the recipient is
Then what?
These payments are considered compensation and require the employer to withhold:
- 6.2% Social Security
- 1.45% Medicare Taxes
In addition, the employer must pay their share of the employment taxes of the total compensation paid out to employees to the tune of:
- 6.2% Social Security
- 1.45% Medicare Taxes
Here’s where the Tax Credit comes in:
The FICA Tip Credit is the same as the employer’s share of the employment taxes on the tips disbursed. If the tipped employees make less than minimum wage, the credit is reduced by the employment taxes the employer would have paid on the difference.
To understand through a real world example let’s take Dinah’s Diner. In 2016, $250,000 was collected in gratuities by the staff, all of whom earn at least minimum wage. Social Security and Medicare taxes are withheld and the employer pays his 7.65% employment taxes, which equals $19,125. Dinah’s Diner’s “FICA Tip Credit” would be equal to the $19,125 they paid on their employees’ tips.
Things to Keep in Mind:
- C-corporations can use the credit to directly reduce the tax liability on the face of their tax return.
- S-corporations and partnerships pass the credit to the shareholders or members via their K-1 schedules where they can then be claimed on their personal income tax returns.
- Tips that are used to meet the federal minimum wage, distributed service charges (including “automatic gratuities” - like an automatic charge of 18% for parties over eight ) are not eligible for the tax credit as they are not considered “free of compulsion.”
- The tip credit is only applicable to tips received in the food and beverage industry, not for delivery driver tips/other hotel employees.
- The credit is available without regard to whether the employees reported the tips to you.
- You can claim the credit within three years from the due date of your return on either your original or amended return (if you haven’t claimed for the past three years, it’s still available!)
As a restaurant owner, it’s important to work with a trusted advisor who can ensure that you are taking advantage of all of the possible tax breaks. For help navigating the “FICA Tip Credit” and all of your restaurant tax needs, contact Jason Meersman, CPA at 425.629.199 or by email at jmeersman@sweeneyconrad.com.