Tip Credit: IRC 45B

IRC Section 45B provides an income tax credit for a portion of employer FICA taxes (Social Security and Medicare taxes) paid with respect to employee cash tips.

Tipped employees are those who customarily and regularly receive more than $30 a month in tips. The FLSA (Fair Labor Standards Act) current minimum wage is $5.15, and the maximum tip provision is $3.02 per hour; therefore an employer may pay a tipped employee as low as $2.13 per hour provided that tips and employer wage equals the FLSA minimum. If an employee's tips combined with the employer's direct wage rate of at least $2.13 an hour do not equal the FLSA minimum hourly wage of $5.15 an hour, the employer must make up the difference.

Introduction

Employers in the food and beverage industry may be entitled to an income tax credit for the FICA taxes (Social Security and Medicare) paid on employee tip income after December 31, 1993. The credit applies only to tips received by food and beverage employees, including buspersons. It is not applicable to other tipped employees. The credit is available without regard to whether employees reported tips pursuant to IRC Section 6053(a).

BOTH of the following requirements must be met to qualify for the credit:

1. Employees received tips from customers for providing, delivering, or serving food or beverages for consumption; and
2. Employer FICA taxes were paid on these tips.

The credit is part of the general business tax credit and is claimed on Form 8846, Credit for Employer Social Security and Medicare Taxes on Certain Employee Tips http://www.irs.gov/pub/irs-pdf/f8846.pdf (Ignore the standard virus message re IRS file, the file is clean).

Type of Credit

It is an income tax credit, claimed on an income tax return, and can only be used to offset any regular income tax liability, not employment tax liabilities.Treatment of IRC 45B credit
A credit is a dollar for dollar reduction of a regular income tax liability, whereas an expense deduction only reduces taxable income. Therefore, credits are usually more beneficial. The credit AND the expense deduction cannot both be claimed. If the credit is claimed, then the social security and Medicare tax applicable to those tips cannot also be claimed as a deduction. Annual evaluation should be done to determine whether the credit or the expense deduction is more beneficial.

The IRC 45B credit is not refundable; if the credit reduces a regular income tax below zero, the negative amount is not a tax refund. However, it is subject to carry back and carry forward provisions of the Internal Revenue Code, as are other components of the business tax credit. See IRC Section 39. Credits arising in tax years beginning after December 31, 1997 may be carried back one year and forward 20 years.

You can claim or elect not to claim the credit anytime within three years from the due date of your return on either your original return or an amended return.

State Minimum Wage Effect

Go to http://www.dol.gov/esa/minwage/america.htm to determine a state’s minimum wage.

Minimum Wage Effect

The credit equals the Social Security and Medicare taxes paid on the tips received by the employees. However, no credit is given for tips used to meet the federal minimum wage rate of $5.15 per hour. For example,

1. If an employee is paid $3.75 per hour and tips of $1.40 per hour are applied to reach the $5.15 minimum wage, then the $1.40 per hour in tips cannot be used toward the credit.
2. If an employee is paid an amount equal to or more than the minimum wage without including tips, then all reported tips can be used in the computation.

Programming the Tip Credit

• 1. Start: Employer wage rate (not to exceed the federal minimum wage rate, currently $5.15) x hours worked
• 2. Add: Employee reported tips
• 3. Lines 1 + 2 = Gross Wages
• 4. Enter Federal Minimum Wage (Currently $5.15 x hours worked)
• 5. Line 3 - Line 4 = Tips eligible under IRC Section45B to compute the income tax tip credit
• 6. Line 5 x 7.65% = Section 45B Tip Credit

Comment: The above procedure can be used with data that is weekly, annual, or for other periods of time.

Example A: State Follows Federal Minimum Wage ($5.15) and FLSA Tip Credit ($3.02)

Condition: Employee works 40 hours. Employer pays employee a $2.13 hourly wage rate (FLSA $5.15 minimum less FLSA $3.02 maximum tip credit). Employee reports tips of $320.

1. Employer direct wage ($5.15 - $3.02 =$2.13) x 40 $ 85.20
2. Employee reported tips 320.00
3. Gross Wages $405.20
4. Less federal minimum wage ($5.15 x 40) 206.00
5. Tips in excess of minimum wage $199.20
6. Eligible IRC Section 45B credit on this weeks pay ($199.20 x 7.65%) = $ 15.24

Example B: State Follows Federal Minimum Wage But Has A Lower Tip Credit

Condition: Employee works 40 hours. Employer pays employee a $2.13 hourly wage rate (FLSA minimum rate after FLSA maximum tip credit). State maximum tip credit is $1.91 per hour. Employee reports tips of $320.

1. Employer direct wage ($5.15 - $1.91 x 40) $129.60
2. Employee reported tips 320.00
3. Gross Wages $449.60
4. Less federal minimum wage ($5.15 x 40) 206.00
5. Tips in excess of minimum wage $243.60
6. Eligible IRC Section 45B credit on this weeks pay ($243.60 x 7.65%) = $18.64

Example C: State Minimum Wage Higher Than Federal But Has No State Tip Credit

Condition: Employee works 40 hours. Employer pays employee the state minimum wage rate of $5.75. Employee reports tips of $320.

1. Employer direct wage ($5.15 federal minimum rate x 40) $206.00 (FLSA rate must be used, not the state’s)
2. Employee reported tips 320.00
3. Gross Wages $526.00
4. Less federal minimum wage ($5.15 x 40 206.00
5. Tips in excess of minimum wage $320.00
6. Eligible IRC Section 45B credit on this weeks pay ($320.00 x 7.65%) = $ 24.48

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