Tips, Tip Credits, and Restaurant Payroll
Two different tip credits, strict pooling rules, and a new worker deduction. Here is how they fit together on your payroll.
Tips make restaurant payroll more complicated than almost any other kind. You are handling money your business did not earn, reporting it as wages, paying tax on it, and following wage rules that change by state. Get it right and you can recover real money. Get it wrong and back-wage claims can follow.
Two different things called a tip credit
The FLSA tip credit is a wage rule: it lets you count tips toward minimum wage. The Section 45B FICA tip credit is a tax credit: it reduces your income tax. They have nothing to do with each other except the name.
Tip reporting basics
Employees who receive $20 or more in tips in a month must report them to you by the 10th of the following month. Many use Form 4070 or a POS tip-declaration screen. You withhold income tax and the employee's share of Social Security and Medicare from their wages, and you pay the employer share (7.65%) on reported tips too. Card tips are already in your system; cash tips depend on declarations, so make declaring part of every server's checkout.
The FLSA tip credit and tip pools
Under federal law, you can pay a tipped employee a cash wage of $2.13 an hour and take a tip credit of up to $5.12 toward the $7.25 federal minimum. The employee must earn more than $30 a month in tips, you must tell them you are taking the credit, and if tips fall short in any workweek you make up the difference. Many states require a higher cash wage, and several (including California, Washington, Oregon, Minnesota, Nevada, Alaska, and Montana) do not allow a tip credit at all. Check the US Department of Labor's state table each January.
| Taking a tip credit | Paying full minimum wage | |
|---|---|---|
| Cash wage | As low as $2.13 federally | Full state minimum |
| Mandatory tip pool can include | Only customarily tipped staff | Back-of-house staff too |
| Managers and supervisors | Cannot take from the pool | Cannot take from the pool |
| Shortfall weeks | You pay the difference | Not applicable |
The FICA tip credit (Section 45B)
Under Section 45B, food and beverage businesses can claim an income tax credit for the employer Social Security and Medicare tax paid on tips, generally on tips above the amount needed to bring a worker up to $5.15 an hour (the minimum wage frozen at its 2007 level). You claim it on Form 8846. As of 2025, the credit also reaches beauty businesses such as salons and barbershops. For a busy restaurant, it can mean thousands of dollars a year that many owners miss.
Owner story
Kevin's servers reported about $210,000 in tips last year. His accountant had been filing his taxes for years without Form 8846. After subtracting the part of tips that counts toward the $5.15 floor, the credit came to roughly $13,000, and they amended the prior years still open to claim more.
Illustrative composite, not a real customer.
The new deduction for tipped workers
Legislation passed in July 2025 created a federal income tax deduction for qualified tips for tax years 2025 through 2028. Workers in occupations that customarily received tips can deduct up to $25,000 a year, with the deduction shrinking once modified AGI passes $150,000 ($300,000 for joint filers). Tips still count for Social Security and Medicare tax, and state income tax treatment varies. Workers claim it on Schedule 1-A.
For you as the employer, the key is reporting. Only tips reported through payroll and shown on the W-2 qualify, and forms now show qualified tips and the worker's occupation separately. Automatic service charges, like a mandatory 18% on large parties, are wages, not tips, so they do not count. Keep voluntary tips and service charges in separate POS buckets.
Myth or fact? Tap to flip
Quick check
A server earns $2.13 an hour plus tips, but a slow week leaves them at $6.40 an hour total. What must you do under federal law?
Words to know
- FLSA tip credit
- A federal wage rule letting employers count some tips toward minimum wage.
- Section 45B credit
- A tax credit for employer Social Security and Medicare tax paid on certain tips.
- Qualified tips
- Voluntary tips in a customarily tipped job that a worker can deduct for 2025 through 2028.
- Service charge
- A mandatory fee added to a bill, treated as wages rather than tips.
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