Both presidential candidates offered a tax law change to make tips non-taxable. A few days after the inauguration, President Trump was in Las Vegas at a rally for "No Tax on Tips." What is so special about tips to justify a law change to make then non-taxable? I can't think of any, but offer these observations to remind us that tips are income just like wages and business income and there is little reason to provide a tax break to these workers - why not provide a tax break to all workers?
1. Tips are income: Income is defined by the US Supreme Court as "an undeniable accession to wealth, clearly realized, and over which the taxpayer has complete dominion" (Glenshaw Glass, 348 US 426 (1955)). Some people suggest tips are gifts so are not taxable. A gift is defined by the US Supreme Court as something given with "detached and disinterested generosity" where the donor expected or expects nothing in return (Duberstein, 363 US 278 (1960)). Someone who receives services at a restaurant, hotel, hair salon, or similar establishment, might offer a tip because they appreciated the service and the amount likely varies by how much they liked the service. It is not a gift. If the giver wants to make a gift to someone they should go up to a stranger and give them money with no expectation of anything in return - that is a gift.
2. More than tipped workers need tax relief: H.R. 8785, Tax Free Tips Act (118th Congress) would have changed the law to say that wages do not include tips and make them not subject to income or payroll taxes. The sponsors offered as a rationale that many people getting tips might be "working a second job to make ends meet" so should be able to keep their money. That sounds reasonable if we are talking about raising the standard deduction for ALL low-income workers, but why single out or assume that only tipped workers are in need of tax relief.
3. Challenges of defining tipped workers: It looks like the key proposal in the 119th Congress based on the number of sponsors is No Tax on Tips Act. It would exempt cash tips from income tax (not payroll tax) and has "guardrails to ensure only traditionally tipped employees will benefit from" the proposal (see 1/16/25 sponsor press release). Do note that it says employees. Thus, contractors, such as your Uber driver and owner of a business, would not benefit from the tip deduction. The deduction is limited to $25,000 for the year and would not apply if the worker's income exceeds $160,000 (this is the amount per the reference to §414(q) in the bill). "Qualified tips" for the deduction are defined as "any cash tip received by an individual in the course of such individual's employment in an occupation which traditionally and customarily received tips on or before December 31, 2023, as provided by the Secretary." Thus, the Treasury and IRS would have to define this employee group. I think that means that there isn't already a list of traditionally tipped industries.
4. Tip versus Service Charges: Some restaurants including ones in DC, automatically add a charge to restaurant bills such as because it was for a group of 6 or more (in DC, even 1 customer gets a 20% fee added). Is that a tip or something else (the DC one appears to be a service charge)? For tax purposes today for rules relevant on tip reporting, a service charge is not a tip (Rev. Rul. 2012-18). The fee is wages if distributed to employees. Will any legislative proposal address whether "forced" tips or service charges are the traditional and customary tips to be non-taxable? Arguably, I think yes, but to me it just doesn't seem like a tip when the business adds the amount to your bill automatically. But this should be addressed in any legislative change (in defining "tip").
5. Challenge of excluding tips from Social Security/Medicare taxes and state income taxes: Any tax big tax bill this year will likely be accomplished via the Budget Reconciliation process so that only 51 votes are needed in the Senate. This process does not allow for changes to Social Security so any tip exclusion in the bill can only remove income taxes (as proposed with No Tax on Tips Act (see 3 above)). Also, I think most states will opt not to conform to a federal exclusion or deduction if enacted due to the loss of revenue and the inequity of providing a tax cut to only a small number of employees. The Budget Lab at Yale estimates that 2.5% of workers earn tip income. At the 1/25/25 rally in Las Vegas, President Trump said over 4 million workers receive tip income and that about 25% of a typical restaurant worker's pay is from tips. Will a state enact a tax change to let about 3% of employees exclude 25% of their pay from taxes with no break to other employees who are at the same pay levels? I don't think so.
6. Permanent or temporary: Will any exclusion or deduction for tip income be a permanent change or temporary? I think if the extension of TCJA expiring tax cuts is temporary, the change for tip income will also be temporary, but who knows.
So, there is a lot to consider on this topic that affects a relatively small number of employees. Given the tax cut for a small number, will other employees, particularly those making minimum wage or a bit more also ask for an equivalent tax cut? I think they should to improve the equity of the proposal - that is, similarly situated taxpayers based on income should be treated similarly. If a tipped employee making $70,000 including tips gets a tax cut, a non-tipped employee also making $70,000 should also get the same tax cut.
What do you think?
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