Fed Tax Incentives: "FICA Tip Tax Credit"
Background: Credit for Employer Social Security & Medicare Taxes Paid on Certain Employee Tips
The FICA Tip Tax Credit under IRC § 45B is part of the general business credit under § 38. It allows eligible employers to claim a credit equal to the employer’s share of Social Security and Medicare taxes (IRC § 3111) paid on tips received by employees in connection with providing food or beverages for consumption on the premises where tipping is customary. See IRC §§ 45B(a), (b); 38(b)(5).
Credit for Employer Share of FICA Taxes Paid
-
Credit equals: Employer’s FICA tax rate (currently 7.65%) × tips exceeding the amount needed to bring wages to the statutory minimum wage threshold.
-
Minimum wage for credit purposes: $5.15/hour (frozen by the Small Business Work Opportunity Act of 2007), even though the current federal minimum wage is $7.25/hour. See 29 U.S. Code § 206(a); Fair Labor Standards Act of 1938 (as amended 29 U.S.C. 201, et seq), Pub. L. No. 110‑28; § 45B(b)(2).
Here's a general example below to help clarify the calculation:
An individual restaurant server works 2,080 hours (hours worked includes all paid time including holidays, vacations, etc.) and is paid $3.13 per hour or $6,510 for the year. The server reports tip income of $15,000 to the employer. The employer withholds and “matches” FICA & Medicare taxes on the server’s combined wages and tips of $21,510. The restaurant’s FICA Tip Tax Credit for the applicable tax year is calculated as follows for this individual server:
Section 45B “minimum wage” amount:
$10,712 (2,080 x $5.15) Server’s combined wages: $21,510 ($6,510 + $15,000)
Less server’s compensation based on $5.15 per hour: ($10,712)
Tip income above $5.15 per hour: $10,798 ($21,510 – $10,712)
FICA & Medicare tax paid: $1,646 (21,510 x 7.65%)
FICA Tip Tax Credit/Employer tax savings: $826 ($10,798 x 7.65%)
Although the example credit amount may appear immaterial for a single employee restaurant server, if you have a staffing of 20 similar employees (waiters, bartenders, etc.), assuming the same hypothetical facts and circumstances noted above, this credit for the year would grow to $16,520 in tax credits for the year to offset your income tax liability.
Eligibility
-
Applies only to food and beverage establishments where tipping is customary.
-
Tips must be reported under IRC § 6053(a); however, the credit also applies to employer FICA tax on unreported tips if tax was paid.
-
See § 45B(b)(1); Notice 2012‑18.
Compliance Rules
-
Employers must reduce wage deductions by the credit amount. See IRC § 280C(a).
-
Credit applies only to tips; mandatory service charges do not qualify. See Rev. Rul. 2012‑18; Rev. Rul. 59‑252.
-
State law may override federal tip credit rules—verify compliance in all jurisdictions. See U.S. DOL Wage & Hour Division.
Service Charge vs. Tip
Rev. Rul. 2012‑18 clarifies that a payment is a tip only if:
-
Made free from compulsion;
-
Customer determines amount;
-
Not be the subject of negotiation or dictated by employer policy;
-
Customer controls recipient.
Absence of any factor suggests a service charge. See Rev. Rul. 2012‑18; Rev. Rul. 59‑252.
Reporting the FICA Tip Tax Credit
Restaurant owners who are incorporated as C-corporations may use the credit to directly reduce the tax liability on the face of the tax return. S-corporations and partnerships would pass the credit to its shareholders or members via their respective K-1 schedules. The shareholders or members would then claim their share of the tax credit on their personal income tax returns.
Update on One Big Beautiful Bill Act (OBBBA) and “No Tax on Tips” Impact on IRC § 45B (FICA Tip Tax Credit)
Does “No Tax on Tips” eliminate the FICA Tip Tax Credit?
No. Employers still pay Social Security and Medicare taxes on tips and can claim the FICA Tip Tax Credit under IRC § 45B. The new law only allows employees to deduct certain tips for income tax purposes—it does not change employer FICA obligations or the credit calculation.
OBBBA Changes
OBBBA introduces new reporting requirements for cash tips and qualified overtime compensation starting in tax year 2025. Employers and payors must eventually provide separate accounting of cash tips and occupation codes on information returns (Forms W‑2, 1099), but penalty relief applies for 2025 because IRS forms will not be updated until TY 2026.
“No Tax on Tips” Provision
OBBBA includes a deduction for qualified tips for employees and self-employed individuals, reported on Form W‑2, Form 1099, or Form 4137, Social Security and Medicare Tax on Unreported Tip Income. This is not a repeal of FICA tax on tips—employers still pay FICA on tips and remain eligible for the IRC § 45B credit. The new provision affects employee-level income tax, not employer FICA obligations.
Practical Effect on IRC § 45B
No change to the FICA Tip Tax Credit mechanics: Employers still compute the credit based on tips exceeding the frozen $5.15/hour minimum wage threshold. Employers must continue to withhold and pay FICA taxes on tips, then claim the credit on Form 8846. OBBBA’s “no tax on tips” provision does not eliminate employer FICA liability or the § 45B credit.
Forward-looking Compliance Notes
-
IRS encourages employers to provide separate tip reporting to help employees claim their new deduction, but this is optional for penalty relief in 2025. Expect form changes in TY 2026 for W‑2 and related reporting.
-
Continue applying IRC § 45B as written:
-
Credit = employer FICA tax (7.65%) × tips exceeding $5.15/hour wage threshold.
-
Reduce wage deductions by credit amount (IRC § 280C(a)).
-
Monitor IRS guidance for TY 2026 reporting changes under OBBBA.
-
Employee-level deductions for tips do not affect employer credit eligibility.
-
IRS Links, Notices, & Filing Requirements
-
-
Claim the credit on Form 8846; include in Form 3800 for general business credit computation.
-
S corporations and partnerships pass through the credit to owners via Schedule K‑1.
-