Throughout the 2024 US presidential campaign, we heard both parties float the idea of “no tax on tips.” But what does “no tax on tips” mean in practice? What will a policy change on tip taxation mean for restaurant owners and restaurant workers? This article takes a comprehensive look at all the proposed “no tax on tips” legislation and lays out how no taxes on tips would work, along with the benefits and drawbacks, and answers some frequently asked questions.
Key Takeaways:
- Three proposed No Tax on Tips bills are working their way through Congress; they are all currently in the committee stage.
- None of the bills addresses state wage and payroll tax laws, only federal income taxes.
- Tipped workers and employers would still need to report tipped income to tax authorities.
What No Tax on Tips Means
“No Tax on Tips” is a legislative movement to reduce federal income taxes and, in some cases, payroll taxes tipped workers and their employers pay on tips. The phrase “no tax on tips” comes from the title of Senate Bill 4621, the “No Tax on Tips Act,” which was introduced in the US Senate in June 2024 by Senator Ted Cruz.
Within weeks, two related bills were introduced in the House of Representatives: the House version of the No Tax on Tips Act (House of Representatives Bill H.R.8941) and House of Representatives Bill H.R.8785, also known as “The Tax Free Tips Act.”
How No Tax on Tips Works
Both the Senate and House versions of the No Tax on Tips Act function in the same way. Both bills establish a tax deduction for tipped workers. So, tipped workers would still report their tips and file their state and federal taxes, but they would deduct all of their “cash tips” from their gross income before calculating their federal income tax. This type of deduction is called an “above the line” tax deduction. The worker’s taxes would then be calculated based on only their base wages without tips.
It is worth noting that these bills designate any monetary tip, whether paid via cash, credit card, or digital payment service, as a “cash tip.” Non-cash tips would be in-kind gifts like concert tickets or bottles of wine. Those non-cash tips would still be taxable in the usual way.
How the Tax Free Tips Act is Different
The House’s Tax Free Tips Act of 2024 is slightly different from the other two bills. This bill exempts tips from both payroll and income taxes. This would reduce the administrative burden on independent restaurant owners and allow tipped employees to keep more of their tips. However, without payroll taxes, there is a chance that tipped workers could make fewer contributions to Social Security and Medicare through FICA tax contributions, which could have repercussions when they reach retirement age.
What is FICA? FICA is an acronym for the Federal Insurance Contributions Act. FICA tax is a federal payroll tax taken from each paycheck to cover Social Security and Medicare contributions. The standard FICA tax is 7.65% from the employee’s check and 7.65% paid by the employer for a total contribution of 15.3% of every paycheck.
Who No Tax on Tips Affects
Research by the Yale University Budget Lab estimates that tipped workers account for 2.5% of the US working population. Additional Budget Lab research finds that over 50% of tipped workers work in the restaurant industry. So, any adjustments to tip taxation would have a huge impact on the way restaurants function.
No Tax on Tips Status
Currently, all three bills updating tip taxation are “in committee.” This means that each bill has been introduced and read by the relevant congressional chamber and is being considered separately by specialized committees in each chamber. These committees may hold hearings to gather opinions from experts or the general public. They’ll also want to see Congressional Budget Office (CBO) projections of the bills’ impact if enacted.
Based on the additional information they develop, the committees may amend the bills before sending them to the Senate Majority Leader or Speaker of the House. Then, it is up to the leaders of each chamber to bring the bills to a vote. Both chambers must vote to pass the same version of the bill before it is sent to the President for signature. So, there is still a long way to go before any of these bills become law.
As of November 16th, 2024, this is the current status of all three bills:
- S.4621 (No Tax on Tips Act): Introduced June 20, 2024, and referred to the Senate Committee on Finance.
- H.R.8941 (No Tax on Tips Act): Introduced on July 8th, 2024, and referred to the House Ways and Means Committee.
- H.R.8785 (Tax Free Tips Act of 2024): Introduced on June 18th, 2024, and referred to the House Ways and Means Committee.
These bills are about 20% of the way to eventually becoming law. Congress passes only a small fraction of the bills that are introduced, typically only 3% and 10% of the bills introduced each session. I will update this article as these bills move—or don’t—through Congress.
No Tax on Tips Origins
The idea of not taxing tips is not new. In fact, the US has only been taxing tips for the past 42 years, since the passage of 1982’s Tax Equity and Fiscal Responsibility Act (TEFRA). Before TEFRA passed, tips were commonly seen as a form of tax-free gift. So, there is some history behind not taxing tips. Many European countries—like Germany—also do not tax tips. However, in those countries, tips typically account for a much smaller percentage of tipped workers’ pay than in the USA.
The current conversation about not taxing tips in the US started during the 2024 presidential campaign. Both President Trump and Vice President Harris spoke about updating the tax code to stop taxing tips. The first of these three bills was proposed in the House after President Trump spoke about not taxing tips at a campaign rally.
No Tax on Tips Benefits
These bills still have a long way to go before they become law. If they do pass, however, there are some benefits to not taxing tips:
- Tipped workers would keep more of their money
- Restaurant owners could reduce administrative work (and costs) and potentially save on payroll tax payments
- Tax-free tips could reduce the restaurant labor shortage by increasing interest in tipped restaurant work
Some major restaurant industry players are interested in the potential positive changes that not taxing tips could have in the restaurant industry. The National Restaurant Association came out in favor of the No Tax on Tips movement and listed these benefits in an August 2024 statement:
“Exempting tips from income tax could benefit the restaurant industry by reducing the administrative burden on small business owners and supporting workers who rely on tips to make a living.”
It is also possible that removing taxes on tips will encourage workers to pursue tipped restaurant jobs as either part-time or full-time jobs. While the restaurant worker shortage is less dramatic in 2024 than it was in 2023, the industry regularly experiences high turnover and many job vacancies. So, even if tipped work only becomes appealing for seasonal jobs in the summer and holiday months, every bit of worker is welcome.
No Tax on Tips Drawbacks
Not everyone is convinced that removing taxes from tips will be positive. There are some very real drawbacks to consider. These include:
- Consumer backlash could reduce tip amounts
- Not taxing tips could decrease worker contributions to Social Security
- Overall restaurant wages could stagnate
- Not taxing tips favors tipped workers over non-tipped workers
The first major downside concerns customer behavior; many restaurant owners and workers I speak with are concerned about public backlash. There has been a lot of media coverage about “tipflation” in recent years, and consumer sentiment about tipping has never felt more precarious. The first concern I hear from everyone is the fear that patrons will dramatically lower their tips or choose not to tip at all.
Workers are also concerned that not paying taxes on their tips will reduce their contributions to Social Security, leaving them empty-handed when they reach retirement. Many restaurant workers wonder if not taxing tips will affect their ability to show proof of income when they need car loans or mortgages. However, the way these bills are currently structured is unlikely to be a problem.
Untaxed tips can be seen as a form of raise for tipped workers. Thus, there will be little incentive to increase worker wages to match the rising costs of living. In the long run, not taxing tips could actually cause tipped wages to stagnate.
Tax policy analysts also point out that not taxing tips would favor tipped workers over other, non-tipped workers who earn similar wages. For example, say, a non-tipped administrative assistant earns $48,000 in annual wages, and a tipped server also earns $48,000 annually. The server would not be taxed on their tips, and so would get a tax break that is not available to the assistant.
No Tax on Tips: Reddit’s Take
In a word, restaurant Reddit is skeptical. Overall, the subreddits focused on restaurant owners and workers doubt that the No Tax on Tips Act will actually pass. “This will never happen, so don’t worry about it” is a phrase that appears many times across related Reddit threads.
Many Reddit restaurant workers also express the opinion that the No Tax on Tips Act is actually the first domino in a chain of future legislation that will ultimately classify corporate bonuses and other wage types as “tips,” thus making those wages un-taxed.
Underlying the general skepticism is the feeling that the No Tax in Tips Act isn’t really about restaurant workers, and even if the bill passes, they don’t expect it to help restaurant workers much. The NY Times notes that this is possible, writing in a recent article, “By one definition of “tip,” many Americans could reclassify their earnings to avoid taxes.”
As the largest tip-reliant workforce in the US, restaurant workers also fear they will bear the brunt of any backlash, and that backlash will be expressed by customers tipping less. Many commenters are also concerned that changes to tip taxation and reporting will impact their ability to show proof of income when tipped workers apply for loans or mortgages. Some workers worry about the impact on social security contributions and whether the changes would reduce their social security incomes when they reach retirement age.
No Tax on Tips FAQ
The No Tax on Tips landscape is still taking shape. These bills can also change in the committee phase. These are the most common questions I’m hearing right now.
Last Bite
The No Tax on Tips Act still has a long way to go before it becomes law, and it may never cross the finish line. If this bill does pass in its current form, the results will be mixed for restaurant owners and workers. While tipped workers will keep more of their tips, there could be implications for future social security benefits. A lot will depend on what happens in Congressional committees and if these bills ever make it out of committee to a full vote. If you or your staff have concerns about how the proposed bill will affect your business, contact your Senators and Congressmen. Now is the time when your voice can have an impact.
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