Tax Planning for Restaurants: Don’t Leave Money on the Table – How the FICA Tip Credit and Other Strategies Save You Thousands
In this guide, we’ll break down what every restaurant owner needs to know about two key tax credits you may be missing. Read on to make sure you’re not leaving money on the table.
If you own or operate a sit-down restaurant, chances are you are laser-focused on daily challenges: labor costs, menu pricing, and staying compliant with regulations. But when it comes to tax planning, many operators are missing out on substantial savings simply because they don’t know what credits are available—especially the powerful (and often overlooked) FICA Tip Credit.
Understanding Tax Credits: The Basics
What Is a Tax Credit and Why Does It Matter?
A tax credit is a direct reduction of your tax bill—dollar for dollar. Unlike deductions (which reduce taxable income), credits reduce your tax liability directly. For restaurants, these can add up to thousands of dollars in annual savings.
Key Credits for Restaurant Owners
- FICA Tip Credit: A federal credit for the employer’s share of Social Security and Medicare taxes paid on employees’ tip income.
- Work Opportunity Tax Credit (WOTC): A credit for hiring employees from targeted groups (e.g., veterans, long-term unemployed).
The FICA Tip Credit: The Hidden Gem
What Is the FICA Tip Credit?
If your employees earn tips—as most servers and bartenders do—you’re required to pay the employer’s share of FICA (Social Security and Medicare) taxes on those tips, even though you don’t directly receive that income. To help offset this cost, the IRS offers the FICA tip credit.
Who qualifies?
- Restaurants where tipping is customary and employees report tips
- You pay the employer portion of FICA taxes on those tips
How Does It Work?
- You pay: Your share of FICA taxes on reported tips.
- You claim: A credit for the amount of FICA taxes paid on tips. If your employees’ wages and tips meet or exceed minimum wage, you can typically claim a tax credit for FICA taxes on tips exceeding minimum wage.
Example Calculation:
Let’s say that your employees reported $200,000 in tips in the calendar year. The employer portion of FICA tax on those tips is $15,300, which you pay in as payroll tax. If you pay your employees at least minimum wage, then your FICA tip credit would be the entire $15,300, and you can use it as a dollar-for-dollar reduction of your income tax.* However, if you pay your servers the minimum wage for tipped employees of $2.13 an hour, you must calculate the dollar amount of tips that brings the hourly wage up to standard minimum wage. In Texas, the minimum wage is currently $7.25 per hour. The difference of $5.12 per hour would be ineligible for the FICA tax credit. Let’s say that the tips that the non-qualified tips accounted for one third of the total tips paid ($200,000 x .33 = $66,000). The tip credit can then be taken on $134,000 of tips ($200,000 - $66,000 = $134,000), resulting in a tax credit of $10,251.
Common Reasons Restaurants Miss Out
- Not tracking or reporting tips accurately
- Setting up the payroll system incorrectly
- Not talking to your tax professional about it, or worse yet, using a tax professional who does not understand the credit
- Assuming only large restaurants qualify
Actionable Steps: How to Capture the FICA Tip Credit (and Other Tax Benefits)
1. Track Tips Accurately
- Require employees to report all cash and charged tips daily.
- Implement a system where employees are required to report (as required by the IRS)
- Use integrated POS systems (e.g., Shift 4, Toast, Square, Union) for automatic tip recording.
2. Work With Your Payroll Provider
- Ensure tip income is properly reported on pay stubs and payroll tax filings.
- Confirm your payroll software or provider is calculating the FICA tip credit eligibility each period.
3. Inform Your Tax Preparer
- Communicate that you want to claim the FICA tip credit.
- Provide detailed tip and wage records for the tax year.
4. Stay Audit-Ready
- Retain daily tip reporting logs, payroll records, and related documentation for at least 4 years.
- Review IRS Form 8846 (Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips) annually with your tax professional.
5. Review Other Credits Annually
- Ask your tax professional to review eligibility for the Work Opportunity Tax Credit and any relevant state credits during your tax planning session.
Work Opportunity Tax Credit (WOTC)
What is the WOTC?
A federal tax credit is available to employers to incentivize them to hire and retain employees from 10 designated groups:
- Long-term family assistance recipient,
- Qualified recipient of Temporary Assistance for Needy Families (TANF),
- Qualified veteran,
- Qualified ex-felon,
- Designated community resident,
- Vocational rehabilitation referral,
- Summer youth employee,
- Supplemental Nutrition Assistance Program (SNAP) benefits (food stamps) recipient,
- SSI recipient, or
- Qualified long-term unemployment recipient.
Although the WOTC is set to expire on December 31, 2025 (meaning only employees hired before December 31st would qualify), we are watching for an extension of this tax provision. Stay tuned.
How does it work?
The WOTC is equal to 40% of up to $6000 of wages paid (maximum credit of $2400 per employee) to an individual who is in their first year of employment, is certified by a local agency (in Texas, the Workforce Commission), and performs at least 400 hours of service for the employer. Certain other restrictions apply.
Actionable steps to qualify for the credit
- On or before the day that an employment offer is made, the employer and the job applicant must complete Form 8850, so make this part of your application process.
- Within 28 calendar days of the employee’s start date, submit the Form 8850 to the state agency that certifies WOTC qualification (in Texas, the Texas Workforce Commission)
- Communicate with your payroll provider to ensure wages and hours worked are properly tracked for qualified employees
- Following receipt of certification form from the local agency, file form 5884 with tax return to take the tax credit*
Don’t Let Tax Credits Slip Through the Cracks
Every dollar you save in taxes is a dollar you can reinvest in your restaurant, your team, or your own peace of mind. Many restaurant owners are surprised at how much the right tax planning can help their business thrive.
Don’t wait until tax season—take action now:
- Review your tip tracking and payroll setup
- Ask your bookkeeper or tax professional specifically about the FICA tip credit WOTC
*Note: If your restaurant is operating under S-Corporation or Partnership status, the tax credits typically flow through to the shareholders or partners, reducing tax at the individual level instead of the business level. You may want to review your business entity structure with your tax professional. There are many considerations that go into determining the best structure for your business. However, tax credits are one factor to consider.
Have questions or want to see if you’re maximizing your credits? Book a complimentary tax review with our experienced team today. Tax laws can be confusing, but you don’t have to navigate them alone. Let’s make sure you keep every dollar you’ve earned.
