Much has been written recently about “no tax on tips or overtime,” and employers should be prepared to help their employees with tip/OT income to determine how much those employees can deduct on their 2025 Form 1040’s, as we discussed in depth in our most recent PayDay. The first step, however, is for employers to ensure they are included in the IRS list of occupations in which tipped employees are entitled to claim 2025 tax deductions (with limits in place). The One Big Beautiful Bill also included an expansion of the long-time “FICA tip tax credit” for “food and beverage establishments” (restaurants, bars, caterers, etc) to the “beauty and wellness industry,” effective retroactively to January 1, 2025. This federal income tax credit for FICA/Medicare tax paid by employers on “tipped employees” is claimed on Form 8846 and has saved many restaurants tens of thousands of dollars in Federal income tax over the past several decades. EMPLOYERS WHO ARE IN THE FOOD/BEVERAGE OR BEAUTY/WELLNESS INDUSTRIES SHOULD CAREFULLY REVIEW THEIR ELIGIBILITY FOR CLAIMING ANNUAL FEDERAL INCOME TAX CREDITS FOR FICA/MEDICARE TAXES PAID ON TIPS PAID TO THEIR EMPLOYEES.
FICA TIP TAX CREDIT ESTABLISHED IN 1993 FOR FOOD/BEVERAGE ESTABLISHMENTS
Restaurants, bars, coffee shops, caterers and related “food and beverage establishments” have been able to claim a credit for certain FICA/Medicare tax paid on tips reported to them by their employees since 1993. The federal income tax credit, claimed on the employer’s business income tax returns on IRS Form 8846, is 7.65% of tips which are reportable to employees as tip income on the amount of the tip income in excess of $5.15 per employee work hour. This credit is available to servers and other restaurant employees who receive tip income from customers who voluntarily tip the employees (mandatory service charges added to restaurant bills do not “count”). An example of how the F tip tax credit works for restaurants/food beverage establishments is as follows:
An employee works 40 hours in a week as a server in a restaurant in which it is customary for customers to tip for services. The employee earns $3.50 per hour in wages and also earns $300 in tips for the week. As such, the employee earns gross wages of 40 X $3.50= $140 in gross wages PLUS $300 in tip income, or $440 for the week. 40 hours X $5.15 per hour= $206, which means no tip tax credit is available on the first $206 earned by the employee. The excess of wages and tips above $206 in this example is $234, and that amount in excess of $5.15 per hour is the amount of tips subject to the FICA tip tax credit. In this example, the FICA TipTax credit the employer can claim for this employee for one week is 7.65% of $234, or $17.90. This federal income tax credit, calculated on IRS Form 8846, is not capped and as such can be worth tens of thousands of dollars in annual Federal income tax. If the employer/business is a “flow through entity,” such as a LLC or S corporation, the FICA tip tax credit flows through on K-1 schedules to be claimed on the owner’s personal income tax return.
The purpose of this FICA tip tax credit was to encourage owners of restaurants/bars to develop a system for employees to report tips to their employers. Statistics have shown that the implementation of the FICA tip tax credit has resulted in increased reporting of tip income by employees to their employers.
The $5.15 per hour is the “baseline” amount before an employer can claim the FICA tip tax credit, and was the federal minimum wage back in year 2007 that was “fixed into law” at that amount per IRS Code Section 45(b).
FICA TIP TAX CREDIT EFFECTIVE JAN 1, 2025 FOR THE BEAUTY/WELLNESS/PERSONAL CARE SERVICES INDUSTRY
Owners of salons, spas, hair stylists, etc. have long lobbied for an employer FICA tip tax credit for their industries, similar to what the food/beverage industry has had since 1993. The OBBBA included a FICA tip tax credit for the “beauty/wellness” industry, for employers in this industry whose “gross tips” are at least 15% of their total gross receipts for a calendar year. It will be up to the employers claiming the FICA tip tax credit to determine IF they are “eligible” for the tax credit based on their specific types of services and whether they meet the “15% tips/gross receipts” test. The “baseline” amount a spa employee must earn in combined wages/tips before FICA tip tax credits can be claimed by a spa/salon/beauty services employer is the current federal minimum wage of $7.25 per hour (NOT the lower restaurant amount of $5.15 per hour). Here is an example of how much FICA tip tax credit is earned by an employer who pays a massage therapist $3.50 per hour plus tips for a 40 hour work week:
The massage therapist earns 40 hours X $3.50= $140 in gross wages plus $300 in tip income, or $440 for the week. 40 hours at the current federal minimum wage of $7.25= $290. The spa can claim a FICA tip tax credit of 7.65% X $150, or $11.47 in income tax credit for this one employee’s one week of work. Like the restaurant FICA tip tax credit, owners of a LLC or S corporation can claim the tax credit from their K-1 schedule on their Form 1040.
WHO USUALLY CALCULATES AND CLAIMS THE FICA TIP TAX CREDITS?
Since the FICA tip tax credits are claimed by the employer on their annual business income tax returns, as a general rule the FICA tip tax credit is calculated and claimed by the tax preparer/CPA for the employer. The employer’s wage deduction is reduced by the amount of the FICA tip tax credit (remember that an income tax credit is generally worth far more than an income tax deduction.)
HOW CAN ACCUPAY HELP YOU CLAIM THE FICA TIP TAX CREDIT?
If we process your payroll and your employees separately report their “tip income” to you, your payroll records and employees’ pay stubs should include the amount of tip income paid to employees for the year. The total may also be included on the employee W-2 form in Box 7, titled “Social Security Tips.”
EMPLOYERS IN THE FOOD/BEVERAGE AND BEAUTY/WELLNESS/PERSONAL CARE INDUSTRIES SHOULD TALK TO THEIR CPA/TAX ADVISOR ABOUT THIS SIGNIFICANT FICA TIP TAX CREDIT!!
This PayDay is for educational purposes only and does not constitute tax and/or legal advice. Any links to external resources are for educational purposes only. AccuPay is not affiliated with nor receives any renumeration from any outside sources. Please consult with your tax and/or legal advisor before applying any suggestions made here or through external links.