Should Tax on Tips Stay or Go?

The debate over tips in the United States is heating up. Data show people often feel pressured to tip, even at places they never used to. And with prices being as high as they are, some find it challenging to tip on top of everything else. Then, there’s the question of whether businesses should pay higher minimum wages instead of having their employees rely on tips. Those issues make tipping a pain point for many. 

But that's not all. With the 2024 presidential election campaign in full swing, the idea of eliminating federal taxes on tips is gaining traction on both sides of the aisle.

This rare alignment between the two major political parties has revived debate over how to support service industry workers, many of whom struggle financially despite working long hours. Both sides at least seem to recognize the potential political benefits of a policy that could impact millions of people.

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But the proposal remains controversial and has advantages and drawbacks that policymakers would have to deal with. So, will eliminating taxes on tips help workers or even come to fruition? 

Here’s more of what you need to know.

Trump and Harris: No tax on tips?

President Donald Trump initially mentioned the idea at a rally earlier this year, some say to appeal to “working-class” voters. 

“To those hotel workers and people who get tips, you are going to be very happy because when I get to office, we are going to not charge taxes on tips, people making tips,” Trump told supporters.

Since then, several Republican lawmakers have introduced bills to implement the policy, and "no tax on tips" has become a core part of campaign messaging for the upcoming presidential election.

On the Democratic side, some lawmakers, especially those from states with large service industries, have also expressed interest. They tout it as a potential way to provide financial relief to service sector workers. For instance, Nevada Democratic Senators Jacky Rosen and Catherine Cortez Masto signed on as sponsors of a Republican-led bill, the No Tax on Tips Act (introduced this summer by Sen. Ted Cruz (R-TX), to exempt tips from federal income tax. 

Most recently, Vice President Kamala Harris, while campaigning in Nevada with vice presidential nominee Gov. Tim Walz (D-Minn.), publicly expressed support for “no tax on tips.” 

“When I am president, we will continue our fight for working families of America, including to raise the minimum wage and eliminate taxes on tips for service and hospitality workers,” Harris, who the Culinary Workers Union endorses, said while speaking to supporters.

The Harris campaign has reportedly emphasized that any such proposal would require legislation from Congress, including income limits and provisions to prevent high-earning taxpayers from taking unfair advantage.

How tip income is taxed by the IRS

It's important to know that under current IRS guidelines, tips received by employees are considered federal taxable income. That includes cash tips, tips received via credit or debit cards, and the value of non-cash tips like tickets or other items. 

• Employees are required to report all cash tips to their employer if the total tips for the month exceed $20. 
• Employers then withhold income taxes, as well as Social Security and Medicare taxes, based on both wages and reported tips. 
• Additionally, service charges mandatory fees added to a bill, are treated by the IRS as regular wages and are subject to the same tax withholdings.

Because of this, those arguing to eliminate taxes on tips point to a key potential benefit of increased take-home pay for some workers. Not taxing tips could provide financial relief to some workers in industries such as restaurants and hospitality, where base wages are often low. 

Another related view is that by reducing the income subject to tax, workers who rely heavily on tip income might have more disposable income to cover living expenses and essentials, improving their financial stability.

Some data also indicate that many in the U.S. support the idea of tax-free tips. For example, a recent poll conducted by the polling and strategic consulting firm Redfield & Wilton Strategies found that 67% of Americans (across party lines) oppose taxing tips received by service workers. 

Eliminating tip taxes: Downsides

Despite what would seem to be obvious benefits, some economists have raised the potential loss of federal revenue as a primary concern with no tax on tips proposals. 

• The Committee for a Responsible Federal Budget estimates that exempting tips from income and payroll taxes could result in a revenue shortfall of $150 billion to $250 billion over the next decade.
• Some say that could exacerbate the national debt and strain government resources.

Other critics argue that the no taxes on tips policy may not effectively target those who need it most. A Yale University analysis found that only a tiny fraction of the workforce would benefit from the tax exemption, as many low-income workers already pay minimal or no federal income tax due to their earnings level. There’s also an argument that employers should raise base pay to support workers relying on tips. And that focusing on tips could hurt efforts to raise the minimum wage.

Note: A study published earlier this year by researchers at the University of Michigan and Carnegie Mellon University found that increasing the minimum wage can benefit workers and businesses. The findings suggest that higher wages have been linked to better employee retention and increased profits for more efficient establishments in the restaurant industry.

Another concern is the potential for abuse. Eliminating taxes on tips could lead to employers reclassifying wages as tips to exploit tax benefits. Or, higher earners could take unfair advantage of the policy without proper safeguards like income limits. 

Opponents argue these scenarios could create disparities among low-income workers and incentivize businesses to prioritize tips over wage increases.

Of course, there are the legislative hurdles. Implementing this policy would require legislative action, as Vice President Harris' campaign acknowledged. The proposal would have to pass through a much-divided Congress.

Taxes on tips: Bottom line

Proposals to eliminate federal taxes on tips present potential pros and cons. While the idea promises increased earnings for service workers, it also presents challenges involving revenue loss and ensuring those who need tax relief the most actually get it.

As Kamala Harris and Donald Trump seek support in key battleground states like Nevada, the debate over tax on tips highlights broader discussions about economic fairness and fiscal responsibility. 

But whether the idea will ever gain enough bipartisan support in Congress to become law remains to be seen. So, stay tuned.

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