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GrataSoft™ Solutions turn tip compliance into strategic advantage - minimizing tip tracking and IRS tip program administration while minimizing audit downside.

John Marshall
EAT, Inc, PO Box 144
5 Crescent Ave, Bld G
Rocky Hill, NJ 08553
tel: 609.786.1004
fax: 609.921.7067

Patent Pending tools and processes, which increase value through enhanced operational compliance and material reductions in administrative burden.

Rebirth of the Tip Credit

By John Marshall

Rebirth of the Social Security Tip Credit

The Social Security Tip Credit has been around for many years, but recently has lost is shine as more and more taxpayers become subject to Alternative Minimum Tax, which precluded it’s use.  That all changed thanks to the “Small Business and Work Opportunity Tax Act of 2007, which took AMT out of the picture once again retroactively to January 1, 2007.


The Social Security Tip Credit is a credit made available to owners of tip-based establishments.  The amount of the credit is equal to the amount of Social Security paid on those tips declared by staff in excess of minimum wage.  More specifically, each employee’s tip declarations, wages, and hours are tallied by month.  For each employee, when their monthly tips plus wages divided by hours worked exceed the minimum wage, the tip amount making up the excess portion is totaled.  The tip credit is equal to the amount of social security match (7.65%) paid by the employer on this calculated total.  This is a credit and not a deduction.  This means that the benefactor may receive a dollar for dollar credit against their tax obligations. 

When one elects the Social Security Tip Credit, the organization can no longer take the matching payroll deduction.  Until recently, owners of Sub-S entities subject to AMT should likely not elect this tip credit because its use may be precluded in that tax year.  Non-election leaves the expense on the books and therefore the deduction remains to lower operating income.  When not limited by AMT, the cost of exercising the Tip Credit is equal to the amount of additional taxes created by the withdrawal of the Social Security expense.  In a 30% tax bracket, approximately 70% of the Tip Credit amount flows through to the taxpayer.

On May 25, 2007, when Congress passed the “Small Business and Work Opportunity Tax Act of 2007,” they also approved an increase in the Federal min wage, and subsequent future increases. Although minimum wage is the driver for excess tip calculations, its present level of $5.15/hour will remain fixed through future increases for the purpose of calculating the Tip Credit.  While it might appear that recipients of the tip credit gave up some ground with the increase of the Federal minimum wage, included was the change allowing tip credit to be applied toward AMT obligations.  Also in many states the minimum wage is so far ahead of the Federal level that there is effective no impact whatsoever.

The new Value of compliance:

When attaching real numbers to all this, an additional $10,000 in declared tips without electing the tip credit could cost the establishment roughly 795.00.  765 for Social security, and an estimate of $30 for state employment taxes (remember at insurance audit time that tips are excluded from wages).  These expenses would reduce S-Corp owner flow-through income.  At a 30% Federal bracket, taxable income would be reduced by roughly $265, or a net cost of $530.  When tip credit is elected, you give up the expenses but gain a credit equal to the social security paid.  You give up a 765 deduction to gain a 765 credit.  Because taxable income increases, the net benefit is worth approximately $500.  Bottom line; if one were faced with a $50,000 tip declaration shortfall, electing the tip credit would cost the company about $4000, but you’d receive a ‘thank-you’ totaling $3825.  Better this outcome, than an audit resulting 5 years of obligations plus interest!

Prior to these changes in 2007, the IRS has offered several tip programs that were designed to encourage employees to increase tip declarations to the required 100% using pay period feedback and training techniques.  If compliant under TRAC, the employer stood to gain audit immunity (although not the staff).  This program came at the administrative cost and complexity estimated by the IRS at 4800 hours annually. 

Beginning 2007, the IRS launched a new tip program called ATIP, or Attributed Tip Income Program.  Simply put, this program sets a minimum tip declaration level for the establishment at 2% less that their previous year average charged tip percentage.  If charged tips for 2006 were 18%, the cost of 2007 ATIP participation would be: attribute 16% of employee sales as if they had declared this amount in tips.  This appears to be the IRS’s new threshold of pain, at which they perceive no value in pursuing an audit.  In fact, compliant operators are afforded audit immunity both for themselves and their employees.  However as one might expect, administration remains unnecessarily complex.

Maximize your Credit:

IRS 45B regulations call for tallying of tips in excess of minimum wage on a monthly basis by employee.  Check with your payroll provider on their specific methodology, and which data is included in tips and which in wages.  There are instances when your actual tip credit could be higher than the value provided to you by a payroll processor. 

If you pay gratuities as wages, make sure that these are being contributed toward wages when calculating each employee’s excess tips.  For servers making $2.13 an hour, gratuities payable will directly displace tips to meet minimum wage.  Similarly, if staff work shifts in “non-home” departments and these wages are paid separately, there is a high degree of likelihood that these wages are also not going to offset min wage.   In several cases, I have seen a 4% – 12% increase in Tip Credit when taking these into account.  Similarly, you may want to reconsider eliminating your house gratuity policy if paid as wages, (see: Is your Gratuity policy costing you money) as this may also be reducing your Tip Credit by another 5% or more depending on your staff’s ability to reach minimum wage.  Remember that gratuities in excess of minimum wage do not count toward your tip credit but as tips they do!

GrataSoft Solutions restaurant tip automation software provides the capability to fully analyze and report year-end Social Security Tip Credit based on each and every shift transaction.  This provides greater accuracy, and in many cases a higher credit amount.

Mr. Marshall is the owner of Main Street Gourmet Eatery and Bakery, Main Street Fine Catering, and Main Street Euro-American Bistro and Bar. He is president of GrataSoft Solutions, developer and publisher of Grata Restrateur and Grata Persona; patent pending solutions for implementing, tracking and managing tip policy, including IRS TRAC, TRDA and EmTRAC Tip Program compliance automation for businesses and individuals. For more information, please visit GrataSoft.com.