Your servers have heard all about it: tips are now deductible on their federal returns. What most restaurant owners haven't heard is the other half of the story — your payroll tax bill on those tips didn't change by a dime, and a decades-old federal credit exists to hand a large piece of it back to you. Many Maryland restaurants have never claimed it.
The 2025 federal tax law created a deduction of up to $25,000 per year for qualified tip income, available for tax years 2025 through 2028. It phases out for higher earners (starting at $150,000 of income, or $300,000 on a joint return), and married workers must file jointly to claim it. We covered the employee side in detail in our full breakdown for Frederick County restaurant workers and employers.
Two details matter most for your dining room:
Only voluntary tips count. Cash left on the table, a tip added to a card, a fair share from a valid tip pool — all qualified. The automatic 18% you add to parties of eight? Not a tip. Mandatory service charges have never been tips in the IRS's eyes, and they don't qualify for the deduction either.
Nothing changed for FICA. Your employees still pay Social Security and Medicare tax on every reported tip, and you still match it at 7.65%. The new deduction only reduces federal income tax.
Here's the sentence to remember: "no tax on tips" is an income tax deduction for your employees — it is not a payroll tax change for you. And Maryland hasn't conformed, so your staff still owe Maryland state and county income tax on every dollar of tips. The deduction never reaches the state return.
| Employee Tip Deduction | Employer FICA Tip Credit | |
|---|---|---|
| Who claims it | Your tipped employees, on their 1040 | Your business, on Form 8846 |
| What it reduces | Federal income tax only | Federal income tax, dollar for dollar |
| Size | Up to $25,000/yr, phases out at higher incomes | 7.65% of creditable tips — no dollar cap |
| Maryland treatment | Not conformed — tips still taxed by MD | Federal credit — Maryland doesn't affect it |
| Expires? | After 2028, unless extended | Permanent |
Under Section 45B of the tax code, food and beverage employers can claim a dollar-for-dollar federal tax credit for the employer FICA taxes paid on most of their employees' reported tips. It's claimed on Form 8846 with your business return, and for S corporations and partnerships it flows through to the owners' personal returns on the K-1.
The quirk is the wage threshold. The credit doesn't apply to tips that bring an employee up to the federal minimum wage — but the law froze that benchmark at $5.15 per hour, the federal minimum as it stood in 2007. Congress never updated it, and the 2025 law left it alone.
That frozen number is great news in Maryland. You pay tipped staff a cash wage of $3.63 per hour, so only the first $1.52 per hour of tips — the gap between $3.63 and $5.15 — is excluded. Everything above that generates a 7.65% credit.
The math for one server: Say a server works about 1,500 hours a year and averages $18 per hour in tips — realistic when Maryland's $15.00 minimum wage means tips must average at least $11.37 an hour just to keep the arrangement legal. Roughly $16.48 of every tipped hour is creditable. At 7.65%, that's about $1.26 per hour — around $1,900 a year in tax credit for that one employee. A restaurant with the equivalent of eight full-time tipped staff is looking at roughly $15,000 a year, every year.
One fine point your preparer should handle: the credit reduces your wage expense deduction by the same amount. You still come out far ahead — a credit is worth more than a deduction — but the two entries have to move together on the return.
Never filed Form 8846? Amended returns can generally recapture the credit for up to three prior years. For an established restaurant with a full tipped staff, that first amended-return review is often a five-figure conversation.
And if you own a salon, spa, or barbershop instead of a restaurant: the 2025 law extended this same credit to beauty and personal-care businesses for the first time, using a $7.25 threshold. Worth a conversation of its own — restaurants and salons are just two of the industries we serve.
The IRS gave everyone a pass for 2025 — no new reporting, penalties waived. That grace period is over. For wages paid in 2026, employers must report each worker's qualified tips in Box 12 of the W-2 under new code "TP" and their Treasury Tipped Occupation Code in new Box 14b. The IRS finalized the rules in April 2026, including the official list of 70-plus tipped occupations, and has signaled no penalty waiver for 2026.
Practically, that means your payroll system needs to separate voluntary tips from service charges now, not in January — a setup our QuickBooks support and training team handles regularly. It also means your employees suddenly have a real financial incentive to report every dollar of tips — under-reported tips are deductions they can't claim. Expect reported tips to rise. Your FICA match rises with them, but so does your Form 8846 credit, which claws most of it back.
Maryland's minimum wage is $15.00 per hour, with the $3.63 tipped cash wage bridged by tips. Montgomery County — where many of our Gaithersburg, Germantown, and Rockville clients operate — sets a higher county minimum that adjusts every July 1 and a $4.00 tipped cash wage, so multi-location operators are running two sets of numbers. Restaurants here in Frederick and the rest of the county follow the state rates.
Annapolis took its biggest swing yet at this system in the 2026 session: a bill to raise the minimum wage to $25, eliminate the tip credit entirely, and lock the framework into the state constitution. It failed — but its sponsors have promised to bring it back. If Maryland ever eliminates the tip credit, the payroll math in this article changes substantially. That's a planning conversation, not a panic — and one more reason to have a CPA who watches Annapolis as closely as the IRS.
Bring us your last three returns. We'll tell you honestly whether the FICA tip credit applies to you, what an amended-return review would recover, and what it would cost. Call (301) 662-6992.
Book a ConsultationYes. The new deduction is claimed by your employees on their own returns — it changes nothing about your payroll. You still withhold federal income tax, Social Security, and Medicare on reported tips, still pay the 7.65% employer match, and still withhold Maryland state and county tax, since Maryland hasn't adopted the deduction.
Yes — that's the normal case in Maryland. Only the first $1.52 per hour of tips (the amount that lifts the $3.63 cash wage to the frozen $5.15 federal benchmark) is excluded from the credit. Everything above that earns the 7.65% credit. If you pay a cash wage of $5.15 or more, every reported tip is creditable.
No. Amended returns can generally recapture the credit for up to the last three years, and the credit itself carries forward if it exceeds your tax in a given year. For most established restaurants that have never claimed it, the recoverable amount justifies the amended-return work several times over.
No — on either side. Mandatory service charges are treated as wages, not tips, so they don't qualify for your FICA tip credit or for your employees' new deduction. If your POS blends them with voluntary tips, separating the two matters more than ever now that 2026 W-2s must report qualified tips on their own line.
By Roy Cogliandolo, CPA · Mercer Flanagan · July 25, 2026
This article is general information, not tax advice for your specific situation. Rules cited are current as of July 25, 2026.