Federal Insurance Contributions Act (FICA) Tip Credit 

Tax Treatment of Tip Income 

Employee tip income is treated as employer-provided wages subject to income tax and 

employment taxes under the Federal Insurance Contributions Act (FICA). Employment taxes 

under FICA, or the FICA taxes, include Social Security and Medicare taxes. Employees who 

receive tips of $20 or more in a calendar month are required to report the amount of tips to their 

employers in the following month. Employers are responsible for withholding employee income 

tax and the employee’s share of FICA taxes and paying the employer’s share of FICA taxes on 

the reported tips. 

How the Credit Works 

An eligible employer may claim a credit against the business’s income taxes for FICA taxes paid 

on certain tip wages. If an employee’s non-tip wages exceed $5.15 per hour, the FICA tip credit 

equals the full amount of the employer’s share of FICA taxes paid on the employee’s tip wages. 

If an employee’s non-tip wages are less than $5.15 per hour, the credit equals the employer’s 

share of FICA taxes paid on the employee’s hourly tip wages after reducing that tip wage by the 

difference between the employee’s non-tip hourly wage and $5.15. The credit is available only 

with respect to FICA taxes paid on tips received from customers in connection with the 

providing, delivering, or serving of food or beverages for consumption, provided that the tipping 

of employees delivering or serving food or beverages by customers is customary. 

The credit is non-refundable and is subject to the carryback and carryforward provisions for 

general business tax credits. The credit is available whether or not the employee reports on his 

or her own tax return the tips on which the employer FICA taxes are paid. Employers cannot 

deduct from taxable income the amount of FICA taxes taken into account in determining the 

credit, and may elect not to have the credit apply for a taxable year. 

Why the Credit is a Tax Expenditure 

Under a comprehensive income tax, businesses may deduct FICA taxes paid from taxable 

income because such taxes are a legitimate business expense. However, targeted tax credits 

generally are not part of a comprehensive tax system. Consequently, this credit is considered a 

tax expenditure because it is an exception to the provisions of a comprehensive income tax that 

serve as the baseline against which tax expenditures are judged. The credit results in a reduction 

in tax liability below the level implied by the baseline tax system. 

History, Rationale and Criticism 

Prior to 1966, tips were subject to individual income tax but not FICA taxes. In 1965, Congress 

amended the law to require employees who received cash tips of $20 or more in a calendar 

month after 1965 to report the tips to employers, and require employers to treat the reported tips 

U.S. Department of the Treasury

Office of Tax Analysis

February 3, 2016
as wages for purposes of withholding income tax and the employee’s portion of FICA taxes. 

Employers, however, did not have to pay the employer’s portion of FICA taxes on the reported 

tips. Tips less than $20 in a month or not paid in cash, while not being subject to withholding, 

continued to represent compensation for income tax purposes. A law change in 1977 required 

employers to pay the employer share of FICA taxes on the employee’s tips, but only on amounts 

up to the federal minimum wage. This ceiling was removed in 1987, and consequently 

employers were required to pay the employer’s portion of FICA taxes on all tip wages. The 

FICA tip credit was enacted in 1993. 

Employers in the food and beverage industry maintain that the credit helps defray the 

administrative costs associated with complying with tip tax law, a cost occurring only in 

industries where tipping is customary. Supporters of the credit argue that, by offsetting 

employers’ FICA taxes on reported tips, the credit provides an incentive for eligible employers 

to report tip income, thereby improving employer and employee income and employment tax 

compliance. They also argue that the credit helps ensure future Social Security benefits for 

tipped workers. 

Opponents of this credit assert that, despite the credit, the underreporting tax gap on tip income 

remains large in the food and beverage industry. They also argue that the credit is unfair because 

it is available only to certain employers in the food and beverage service sectors and not 

available to employers in other industries. Furthermore, the favorable tax treatment on tips 

relative to other cash compensation unduly encourages employers to provide income in the form 

of tips instead of wages. The Administration has proposed to repeal the credit since its FY2016 

Budget. 

The Size of the Tax Expenditure 

The Office of Tax Analysis estimates that, for tax year 2012, C corporations used $0.5 billion in 

non-refundable FICA tip credits and individual taxpayers used $0.6 billion. The associated tax 

expenditure, that is, the value of the credit in excess of the deduction that would otherwise have 

been allowed under the baseline tax, is estimated to be $1.05 billion for FY2017. This estimate 

of tax expenditure does not incorporate changes in taxpayer behavior that may result if the credit 

is repealed, such as a reduction in tip reporting. Taking into account behavioral changes, the 

Office of Tax Analysis estimates that repealing the FICA tip credit would increase federal 

receipts by $0.73 billion for FY2017. 

Tentative Credits by Firm Size and Type 

As background, the table below contains estimates of the tentative FICA tip credit by firm size 

(measured by total income) and entity type. Tentative credits are credits before limitations. This 

table focuses on tentative credits attributable to the business’s own activity in 2012, so it

excludes credits passed through from other businesses (e.g., from a partnership to a C 

corporation) and excludes carryforward and carryback amounts. For tax year 2012, about 8,100 

C corporations, 36,600 S corporations, 16,950 partnerships and 4,750 sole proprietorships 

U.S. Department of the Treasury

Office of Tax Analysis

February 3, 2016
reported tentative credits for the FICA taxes they paid on employee tips during the tax year. In 

aggregate, C corporations generated about $0.5 billion in credits and pass-through businesses

generated nearly $0.8 billion. These amounts differ from the estimates of credits actually used 

(given above) because of transfers of credits across firms and restrictions on credit use imposed 

by nonrefundability. The amount of tentative credits was concentrated among C corporations 

with incomes above $100 million and pass-through entities (including S corporations and 

partnerships) collecting between $1 million to $10 million of income. 

Table 1: Aggregate Tentative FICA Tip Credits by Firm Size and Type (Tax Year 2012) 

Number of 

firms

Thousands 

($)

Number of 

firms

Thousands 

($)

Number of 

firms

Thousands 

($)

Number of 

firms

Thousands 

($)

Total Income

 < $1 million 5,500 20,500 19,950 54,200 5,300 19,200 3,250 10,700

 $1 million-$10 million 2,250 45,700 16,050 234,900 10,850 225,100 1,450 17,900

 $10 million-$25 million 100 12,800 400 38,000 400 32,200 50 3,600

 $25 million-$100 million 100 37,400 150 27,600 300 60,700 * *

 $100 million-$1 billion 100 166,700 50 18,600 100 52,200 * *

 > $1 billion 50 238,700 * * * * * *

Total 8,100 521,800 36,600 373,300 16,950 389,400 4,750 32,200

* Fewer than 25 firms.

C Corporations S Corporations Partnerships Sole Proprietorships

U.S. Department of the Treasury

Office of Tax Analysis

February 3, 2016