What Is the Tip Tax Credit & How to Claim It?

The Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips is a federal tax benefit for businesses in the food and beverage industry. The credit’s purpose is to offset the employer’s share of FICA taxes paid on the tip income that employees report.

Employer Eligibility for the Tip Tax Credit

To qualify, an employer must operate a business like a restaurant or bar where tipping is customary for serving food and beverages. The employer must also be liable for and pay the employer’s portion of FICA taxes on reported employee tips. For this credit, a “tip” is a discretionary payment from a customer that an employee reports to the employer. This is distinct from automatic service charges or mandatory gratuities, which are treated as wages and are not eligible for the credit.

Accurate record-keeping is required for eligibility. Employees must report their tips to the employer, who must then withhold taxes and pay the matching share of FICA on both direct wages and reported tips. The credit is only available for FICA taxes paid on these properly reported tips.

Calculating the Credit Amount

The tip tax credit is only available for FICA taxes paid on tips that exceed a certain wage threshold. This threshold is based on the federal minimum wage as it stood on January 1, 2007, which was $5.15 per hour. This rate is used for the calculation regardless of the current federal or state minimum wage. The credit is the employer’s 7.65% share of the FICA tax rate applied to the amount of “creditable tips.”

To determine the creditable tips for an employee, first calculate the wages that would have been paid at the $5.15 per hour rate by multiplying the total hours worked by $5.15. Next, compare this amount to the actual cash wages (excluding tips) paid to the employee. If the wages calculated at $5.15 per hour are more than the actual wages paid, the difference is not creditable.

This difference must be subtracted from the employee’s total reported tips for the period. The remaining amount is what qualifies for the credit. For example, an employee who worked 100 hours and was paid $375 in cash wages would have earned $515 at the $5.15 rate. The difference is $140, so if the employee reported $1,000 in tips, only $860 ($1,000 – $140) would be creditable tips.

The total creditable tips for all eligible employees is then multiplied by the 7.65% FICA tax rate to find the final credit amount. Using the previous example, the credit would be $65.79 ($860 x 0.0765). If an employee’s wages already exceed the $5.15 per hour rate before tips, all their reported tips are eligible for the credit calculation.

Completing Form 8846

IRS Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips, is the designated document for claiming this credit. This form is where an employer formally calculates and reports the credit amount to the IRS. Line 1 of the form asks for the total tips on which you paid the employer’s share of FICA taxes.

The form then guides you to calculate the non-creditable portion of the tips based on the $5.15 per hour rule. You will subtract the non-creditable tips from the total tips to arrive at the creditable tips on line 3. On line 4, you multiply the creditable tips by the 7.65% FICA tax rate to determine your credit amount. The result is the total credit you are eligible to claim.

Filing for the Credit with Your Tax Return

After completing Form 8846, you must integrate it into your business’s annual income tax return. The credit from Form 8846 is a component of the General Business Credit, so the total amount is transferred to Form 3800, General Business Credit. The total from Form 3800 is then carried to your primary business tax return, depending on your business structure:

• Corporations use Form 1120.
• S corporations use Form 1120-S.
• Partnerships use Form 1065.
• Sole proprietors use Schedule C (Form 1040).

You must attach both Form 8846 and Form 3800 to your income tax return. Employers have up to three years from the due date of the original return to claim the credit by filing an amended return.