If you own a restaurant with tipped employees, you're paying employer taxes on money that was never yours. Tips go straight from the customer to your employee. You never touch them. But the IRS still expects you to pay employer Social Security and Medicare taxes on every dollar.
There's a tax credit designed to offset that cost, and a surprising number of restaurant owners have never claimed it.
At Patrick Accounting, we've worked with restaurant owners for over 20 years. One of the most common things we see when a new client comes on board is that they were eligible for the FICA tip credit and had no idea. We're talking about credits worth $30,000 or more per year, just sitting there unclaimed.
In this article, we'll explain why this credit exists, how it works, what changed under the One Big Beautiful Bill, and what you should be asking your accountant about right now.
Why the FICA Tip Credit Exists in the First Place
The logic behind this credit is actually pretty simple once somebody explains it, but almost nobody does.
Under federal law, a tip is not considered a wage. It's a pass-through from customer to employee. That's why tips aren't subject to wage garnishments like child support. They're not technically wages.
But even though tips aren't wages, the IRS still requires you to pay your share of FICA taxes (Social Security and Medicare, totaling 7.65%) on every dollar of tips your employees report. You're paying employer tax on money that, by legal definition, was never yours.
The FICA tip credit was created to offset that burden. It gives you a dollar-for-dollar tax credit (not a deduction) for the employer FICA taxes you paid on tips above a certain threshold. That threshold is based on $5.15 per hour (the federal minimum wage as it stood in 2007, frozen at that level for this calculation).
A credit reduces your actual tax bill, not just your taxable income. If your FICA tip credit is $30,000, that's $30,000 directly off what you owe the IRS.
Does it make sense that this credit even needs to exist? Not really. If the government ever indexed the federal tipped minimum wage to the actual minimum wage, the credit would essentially disappear. But they haven't, so the gap between the $2.13 tipped rate and the $5.15 threshold is where this credit lives. And as long as it's there, you should be claiming it.
How the FICA Tip Credit Works
Your accountant handles the specifics on IRS Form 8846, but here's the basic idea.
For each tipped employee, take their total reported tips plus base wages, and subtract the threshold amount ($5.15 multiplied by hours worked). The employer FICA taxes you paid on the amount above that threshold is your credit.
Let’s put some real numbers on it. Say you run a restaurant with 25 tipped employees. Each one works 160 hours a month, earns a base wage of $2.13/hour, and reports $2,000 a month in tips.
For each employee, each month:
- Combined wages and tips: ($2.13 × 160) + $2,000 = $2,340.80
- Threshold amount: $5.15 × 160 = $824.00
- Excess (the part that generates the credit): $2,340.80 − $824.00 = $1,516.80
- Your credit: $1,516.80 × 7.65% = $116.04 per employee per month
- 25 employees × $116.04 × 12 months = $34,812 per year
Scale that across your team:
That's nearly $35,000 straight off your federal tax bill. Every year. And if you've never claimed it, you can amend up to three prior years, which in this example would recover over $100,000.
The credit is nonrefundable, meaning it can reduce your tax bill to zero but won't generate a refund. However, any unused credit carries forward to future years. Even in a loss year, the credit doesn't disappear. It's waiting for you when you're profitable again.
Why So Many Restaurant Owners Miss This Credit
The most frustrating part is that we regularly see restaurant owners who have been eligible for years and never claimed this creit. And when that happens, there are usually two parties that dropped the ball.
- The restaurant owner didn't know to ask. That's understandable. You're running a business. Nobody expects you to know every line item in the tax code.
- The accountant didn't evaluate it. If your accountant works primarily with restaurants, the FICA tip credit should be one of the first things they look at. But if they only have one or two restaurant clients, they may not even think about it. The credit's existence doesn't make intuitive sense, so if you don't work with restaurants regularly, it's easy to overlook.
Then there's the coordination problem. The data your accountant needs to calculate this credit (hours worked, tips reported, base wages paid, broken down by employee by month) lives in your payroll system. If your payroll provider and your accountant aren't talking to each other, nobody connects the dots. Your payroll company doesn't know you're missing a tax credit. Your accountant doesn't have the payroll data to claim it. And you're stuck in the middle, not even knowing the opportunity exists.
This is exactly why we believe payroll and accounting work better under one roof. When our team at Patrick Accounting handles your books and our sister company Whirks handles your payroll, the FICA tip credit isn't something that gets "discovered" three years later. It's something we evaluate from day one.
What Changed Under the One Big Beautiful Bill
The One Big Beautiful Bill Act, signed into law on July 4, 2025, made several changes that affect businesses with tipped employees. Here's what matters most.
The FICA tip credit is now permanently expanded to beauty and personal care businesses.
For the first time, salons, spas, barbershops, and nail salons can claim this credit. If you're in one of these industries, this is brand-new territory for you, and it's worth exploring with your accountant immediately.
There's a caveat, though. Beauty service employers use the current federal minimum wage ($7.25) as their threshold instead of $5.15, so the credit per employee is smaller. And because the credit is nonrefundable, it only helps if your business is actually profitable. We've already had conversations with salon owners who got excited about the expansion, only to realize that depreciation and startup costs had wiped out their current taxable income. The credit will carry forward, but it's not the immediate windfall some were hoping for.
"No Tax on Tips" is your employee's benefit, not yours.
This provision allows employees to deduct up to $25,000 in tip income from their personal federal taxable income. It's a meaningful break for your team. But it has zero impact on you, the employer. You still report all tips. You still pay employer FICA on all tips. The employee takes the deduction when they file their personal return. Don't confuse this with the FICA tip credit. They're completely different things aimed at different people.
The overtime exemption is trickier than it sounds.
Employees can now exclude the premium portion of overtime pay (just the extra "half" in time-and-a-half) from their taxable income, up to $12,500. Only the premium portion, not the full time-and-a-half rate. It's a harder calculation, and there's going to be confusion around it when W-2s start reflecting these changes in 2026.
What You Should Be Asking Your Accountant Right Now
If you have tipped employees, here are the conversations that need to happen before your next tax return gets filed.
"Have we been claiming the FICA tip credit?"
If the answer is no and you've been eligible, the follow-up is immediate: You can amend up to three prior years of tax returns to recover what you missed. For a restaurant with 20+ tipped employees, three years of unclaimed credits could easily add up to six figures.
"Does our payroll system capture the right data?"
Your accountant needs monthly breakdowns of hours worked, tips reported, and base wages for each tipped employee. If your payroll system can't produce that, you've got a data problem that needs to be fixed before anything else.
"Are our payroll and accounting teams actually coordinating?"
The FICA tip credit sits right at the intersection of payroll data and tax filing. If those two providers aren't communicating, this is exactly the kind of credit that falls through the cracks. We see it happen all the time.
"Are we ready for the 2026 W-2 changes?"
Starting with the 2026 tax year, employers will need to separately report qualified cash tips on W-2s and assign Treasury tipped occupation codes for each tipped employee. If your payroll system isn't set up for that, now is the time to get ahead of it, not in December when you're trying to close out the year.
The FICA Tip Credit Is Too Much Money to Leave on the Table
The FICA tip credit isn't complicated once you understand why it exists. Tips are a pass-through, not a wage, and the government gives you a credit for the employer taxes you paid on that pass-through. The hard part is making sure someone is actually paying attention.
If you're a restaurant owner, this credit could be worth $30,000 or more every year. If you've never claimed it, three years of amended returns could put six figures back in your business. If you're a salon or spa owner, 2025 is the first year you're eligible.
At Patrick Accounting, this is one of the first things we evaluate for every restaurant client. It's too much money to ignore and too common for it to go unclaimed.
If you're not sure whether you've been claiming this credit, or you want to know what the OBBB changes mean for your specific situation, schedule a complimentary consultation with our team.
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