FICA Tip Credit and Recent New York City Determination
As you are aware, the Federal “Credit for Employer Social Security and Medicare Taxes,” commonly referred to as “the FICA Tip Credit,” was instituted to encourage tip reporting and securing Social Security benefits for tipped workers. Restaurant owners that are incorporated as C corporations would use the credit to directly reduce their tax liabilities on their corporation tax filing. S corporation, in contrast, would pass the credit to their shareholder or members, who would claim them on their personal income tax returns. If a restaurant owner elects to utilize the FICA Tip Credit for federal purposes, they forego the deduction of the Social Security and Medicare taxes. That is, the IRS allows restaurants to take a tax deduction for the FICA tax expense it pays on employee tips or a FICA Tip Credit related to those expenses, but not both (IRC Section 45 (B)(c)).
Most states and local taxing authorities do not have a corresponding credit for corporation and unincorporated business tax purposes. Thus, FICA taxes paid, but not deducted for federal tax purposes, are often not allowed as a state or local deduction, but few states or local jurisdictions have issued definitive guidance on this matter.
Historically under audit, New York City has disallowed the FICA Tip Credit deduction as a modification; this is irrespective of the fact that we have successfully secured a negotiated 20% allowable subtraction. However, a recent New York City Administrative Law Judge (“ALJ”) determination, which granted the City’s motion for summary judgement, held that the FICA Tip Credit cannot be taken as a subtraction modification (In the Matter of the Petition of ARK Restaurants Corp. TAT(H)16-18 (GC)). That is, the ALJ ruled without the need for a formal hearing on the merits since it was determined that there were no facts in dispute and the law was clear on the issue.
In summary, the ALJ determination’s reasoning for granting summary judgement included:
1. Analysis of how the benefit is received at the Federal level. i.e. a credit is allowed, but to avoid a double benefit, the expense (FICA Tip Credit Amount) must be subtracted accordingly;
2. Federal Taxable Income is the starting point for NYC general corporation tax purposes i.e. starting point for Entire Net Income. (This would not include a deduction amount as it is required to be subtracted from the allowable expenses);
3. There are specific enumerated additions and subtractions from the starting point (FTI) and IRC Section 45B credit is not specifically included in the Administrative Code or GCT as a modification and;
4. The choice was made by the Taxpayer to either take a deduction or a credit at the Federal level and thus they are bound by that decision. There is no “allowable” business expense available at the city level.
Based on the ARK Restaurant Corp decision, there is now administrative legal precedent related to the FICA Tip Credit deduction amount. It is our understanding that although this case is being appealed, city auditors are now using this guidance to issue their workpapers/assessments and are disallowing any FICA Tip related subtraction modification, and our previous arguments to secure a negotiated settlement on this issue appears to be no longer be viable unless Ark Restaurant is ultimately successful with its appeal. Thus, it is recommended, at this point, that none of our clients take the FICA Tip Credit deduction at the City level. If such deduction is taken, the client should be made aware of the risks of taking such a FICA Tip Credit deduction in the event of audit scrutiny.
Given the current legal precedent at the City level, caution needs to be taken on the New York State tax filings. Although New York State is not necessarily bound by the City’s determination, there is clearly risk if such a position is taken and we need to evaluate whether we can sign such a tax return.
As noted above, Ark Restaurant has filed an exception/appeal, which is currently pending. We will continue to monitor these developments and keep everyone posted.
Now for a bit of good news— The impact of this unfavorable ruling will be somewhat mitigated by the Federal benefits afforded in the newly enacted 199A qualified income deduction.
If you have any questions, please call Arvinder Kaur or Corey Rosenthal.
Corey L. Rosenthal, JD
State and Local Tax Services
Arvinder Kaur, CPAManager
State and Local Tax Services
Subject matter expertise
JD, Principal, Practice Leader, State and Local Tax (SALT) Services
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