By James Jenco
If you own a food and beverage establishment, you might be overpaying the IRS in payroll taxes. That could be the case if you’re not taking advantage of IRC 45(B). This rather little-known federal tax deduction could save you hundreds or even thousands of dollars a year, depending on the size of your tip-eligible workforce. Here’s how it works.
Taxing Issues
As you probably know, it’s your responsibility to pay the employer withholding tax on the FICA and Medicare wages of your employees. However, some of your food and beverage service employees are actually making much more than the minimum (or sub-minimum, depending on your state) wage you pay them, once their tips are taken into consideration.
That means that when you submit withholdings for the actual wages of these tip-eligible employees, it includes payments that you didn’t actually make to them — your customers did. That’s why the 45(B) credit is so valuable to your business as an offset to what you pay in Federal payroll taxes.
How 45(B) Works
The IRS allows you to take a credit to offset the 7.65 percent you pay for staffers’ FICA and Medicare withholdings on the part of their total income collected in tips. So, consider this example: a New York City restaurant pays the Federal withholding tax on $20 per hour that ten tip-eligible employees made, each working 2,000 hours during the tax year. Hence, the business pays the IRS 7.65 percent of $400,000 ($40,000 in wages for each employee x ten employees), for a total of $30,600 ($400,000 x 7.65 percent).
However, the restaurant only paid the employees $7.50 per hour (the current city minimum wage), meaning that they each made an additional $12.50 in tips to make that $20 hourly total. Therefore, according to 45(B), the restaurant could gain a credit of 7.65 percent of the total wage collected by each employee over $7.50 per hour. So in our example, the business could be credited for $19,125 (7.65 percent of $12.50 per hour x 2,000 hours per employee x 10 employees).
This credit should be claimed on Form 8846, Credit for Employer Social Security and Medicare Taxes on Certain Employee Tips.
Worth the Effort
Easy money, right? Not necessarily. In order to take advantage, your tip-eligible employees must document their tip totals on IRS Form 4070, Employee’s Report of Tips to Employer.
That might be a challenge for two reasons. First, it can be difficult to get wage employees to take the time and effort to provide documentation. Second, memories are faulty and it can be in their best interest to under-report the amount collected in cash tips. You can provide motivation by making your people turn in a weekly or bi-weekly accounting before picking up a paycheck. If most of your employee tips are in electronic form, as is the case more and more today, the documentation will be easier and probably more accurate.
Even if there are a few hassles, the tax savings could be well worth the effort, as my example indicates. Simply get an efficient documentation process in place and reap the tax rewards.
As a manager at Wiss & Company LLP, James Jenco provides tax, auditing, consulting and bookkeeping services for a range of clients. He can be reached at (973) 994-9400 or jjenco@wiss.visioncreativegroup.com.