Description

• Normally, employers and employees each pay 6.2 percent of the employee's wages in FICA tax. The FICA tax rate does change at times. For example, in 2011 Congress cut the employee share to 4.2 percent, but left the employer's share unchanged. Tips are wages under IRS rules and so are subject to FICA tax. Tipped employees are supposed to report all tips. In some cases, tip amounts are known to employers, as when a customer adds the tip to a credit card payment. However, many customers give tips in cash directly to employees who might not report the money.
  
  

Tip Credit

• Employers can take a tip credit against wages paid to tipped employees. As of 2011, the maximum tip credit was $5.12 per hour. Employee-paid wages had to be at least $2.13 per hour, bringing the combined total to the 2011 minimum wage of $7.35 per hour. Employers must pay their share of FICA tax on the entire amount and on any declared tips over and above the tip credit. Suppose a waitress works 20 hours one week and declares $300 in tips. The maximum tip credit equals 20 hours multiplied by $5.12, or $102.40. The employer-paid wages are $42.60 (20 hours * $2.13). The excess of declared tips over the tip credit equals $300 minus the $102.40 tip credit, or $197.60. The employer must pay FICA tax on the employee-paid wages, the tip credit amount and on the tips declared in excess of the tip credit amount, which in this example come to a total of $342.60.
  
  

Allocation

• Not all tipped employees fully comply with the rule to report all tips. For this reason, the IRS requires employers to assume a tipped employee receives tips equal to at least 8 percent of sales. For example, suppose a restaurant waiter serves customers who spend a total of $2,000 in a week. However, he declares only $120 in tips. Eight percent of $2,000 is $160. The employer must allocate an additional $40 in tips to that waiter for tax purposes. That is, the waiter will have taxes deducted from his pay based on the assumption he made $160 in tips. The employer must also pay FICA tax on the additional $40 allocated to the waiter.
  
  

Limitations

• An employer is not liable for the employer-paid portion of FICA tax in three circumstances. If an employee receives less than $20 in tips in a calendar month, the money is not considered wages and need not be reported. When a tipped employee exceeds the annual income limit for FICA tax ($106,800 in 2011), there is no FICA tax liability on any additional earnings on the part of the employee or the employer. Finally, employers are not liable for FICA taxes due on unreported tips.