How FICA Tips Credit Works & Help Business

It’s estimated that more than 3 million Americans work in a job where they are tipped.

Whether they are working in a restaurant or bar, a hairdresser or one of the many other tipped jobs, workers often make more in tips than they do in wages.

In fact, while the federal minimum wage for non-tipped workers is $7.25, the minimum wage for tipped employees is just $2.13 per hour. This lower wage can only be put into effect if employees receive at least $30 per month in tips.

What this means is that employers are allowed to count an employee’s tips towards their obligations to pay them a minimum wage. This is called a “tip credit”.

But what is a tip credit and how does it work? Let’s take a closer look.

Here’s What We’ll Cover:

What Is a FICA Tip Credit?

How Does It Work?

What Constitutes a Tip?

Key Takeaways

What Is a FICA Tip Credit?

The Fair Labor Standards Act, or FLSA, allows employers to pay less than the normal minimum wage if their tips make up the difference.

The difference between the amount of money you pay your employees and the standard minimum wage is called a tip credit.

A FICA tip credit is a form of relief for businesses that pay an employer’s share of employment taxes. This is paid on tip income to their employees by a third party, which tends to be customers.

When it comes to paying taxes, the employer will pay the standard social security tax of 6.2%, but only on the first $142,000 of earnings. They will then pay a 1.45% medicare tax on top of that.

That means that the tax rate is 7.65% on earnings.

How Does It Work?

While this all may sound quite confusing, it’s relatively simple when put into practise. Here is an example of how you would calculate your FICA tip credit:

• You pay your employee an hourly wage of $3 per hour.
• The employee then receives tips from customers that are equal to $7 per hour. This means that the employee has earned $10 per hour.
• The employee worked a total of 10 hours during this period. Therefore their total gross wages amount to $100.00.
• The employer is only required to pay FICA taxes at the minimum wage rate of $7.25.
• So the total FICA taxes owed is on the gross wages of $72.50.
• The employer can then receive a FICA tip credit for the difference; $100 – $72.50 = $27.50 gross.
• With the FICA tip credit of 7.65%, you could claim a credit that equals $2.10; $27.50 x 0.0765.

This would mean that for every $100 each of your employees earns, you can claim a tax credit equal to $2.10. That may not sound like a lot, but if you have a popular business with customers that tip well, this money can add up fast.

What Constitutes a Tip?

For something to qualify as employee tips, the payment from any customer must meet four conditions:

1. A customer must not be compelled to make the payment.
2. The customer must have the right to determine how much to pay.
3. The payment cannot be negotiated or dedicated by any employer policies.
4. The customer must have the right to decide who receives the payment.

To give an example. A service charge applied to a large party or at a catering event that has then been equally divided between the servers won’t qualify as a tip.

Key Takeaways

The FICA tip credit is a useful tax break for any sized business in the service industry.

This is a better tax break the more money you and your employees make. So for business owners who run a business that excels in customer service and customer turnaround the better the relief will be. Your employees will make more money, and your business will receive more tax relief.

Are you looking for more business advice on everything from starting a new business to new business practices?

Then check out the FreshBooks resource hub.

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