Restaurants are required to report tip income earned by their employees. This tip income is treated as wages, so both the employer and employee must may social security and medicare tax on these amounts. However, the employer can get most of their payroll taxes back through a credit claimed on Form 8846.
The credit calculation is fairly straightforward. It is 7.65% of “eligible tips”. Eligible tips are tips that exceed a base hourly rate of $5.15 per hour. If you pay your tipped employees greater than $5.15 per hour, all the tips are eligible. If not, the tips required to increase the employee’s pay to $5.15 per hour are ineligible.
For even small restaurants this credit can be very significant. C-Corporations claim the credit as part of the General Business Credit. Flow-through entities (partnerships and S-Corps) calculate the credit on their return and then report the credit to the owners on schedule K-1. The owners then get the benefit of the credit on their personal returns.
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