Reality check, please: Pros and cons of tax-free tips

Courtney Ellis works as a server at the Cosmopolitan hotel and casino in Las Vegas. At a roundtable hosted by the Nevada chapter of the Culinary Workers Union, Ellis and almost a dozen other hospitality workers spoke with Rep. Steven Horsford, D-Nev., on Feb. 20 about his proposed bill to eliminate federal taxes on tips.

“I definitely am concerned with the implications of not being taxed on tips,” Ellis said. “I would love that, but I just want to know what that would look like for the future for everyone.”

Horsford isn’t the first to suggest getting rid of taxes on tips. President Donald Trump initially suggested it on the campaign trail in Las Vegas last June. Also in Vegas, former Vice President Kamala Harris made a similar promise while campaigning in August.

“When I get to office, we are going to not charge taxes on tips,” Trump said at the time. “We’re going to do that right away, first thing in office.”

Trump reiterated his campaign promise at a conference in Miami on Feb. 19. “I’ll be working with the Republican Congress to pass the largest tax cuts in American history,” he said. Less than a week later, House Republicans passed a budget resolution to implement $4.5 trillion in tax cuts over a 10-year period, opening the door for a tax-free tips policy in the future, even though the proposal didn’t explicitly mention tips.

Taxing tips dates back to the 1982 Tax Equity and Fiscal Responsibility Act (TERFA). Established to reduce a blooming federal budget deficit, TERFA mandated, among other things, that employees report tips as part of their income.

Today, workers must report tips if they make at least $20 per month. As of 2023, tipped earners represented about 2.5% of U.S. employees, according to Yale University’s Budget Lab. About $38 billion in tips were reported to the IRS in 2018, the most recent data available, although the actual number could be much higher since cash tips are often paid in cash and hard to track.

The Tax Policy Center estimates if the government removes taxes from tips, tipped employees would receive an average yearly tax cut of $1,800, provided that legislation only targets federal income tax. Estimates of the cost to the federal government in tax revenue range from $107 billion to $118 billion over the next 10 years.

Ending taxes on tips is one of several tax cuts Republicans hope to enact. They want to renew Trump’s signature 2017 Tax Cuts and Jobs Act, which expires later this year. Some lawmakers such as Rep. Thomas Massie, R-Ky., say that move might be irresponsible since it could add to the federal deficit. Republicans are also eyeing additional tax cuts for seniors.

In January, Republican lawmakers introduced three bills—two that gained bipartisan support— with specifics about ending taxes on tipped income. Democratic Rep. Horsford’s Tipped Income Protection and Support (TIPS) Act, reintroduced in February, would eliminate taxes on tips and remove the federal subminimum wage, set at $2.13 per hour for tipped workers.

The proposed measures have support from labor unions, including the National Restaurant Association and the Nevada chapter of the Culinary Workers Union. “Eliminating taxes on tips would put cash back in the pocket of a significant number of workers in the restaurant and foodservice industry,” National Restaurant Association spokesman Sean Kennedy said in a news release.

Still, some analysts are concerned about the implications of the change, especially if the language isn’t clear. “That is probably the biggest sort of design question, just translating the slogan into an actual policy,” said Alex Muresianu, a senior policy analyst for the Tax Foundation.

Muresianu explained that tax-free tipping could lead to behavioral changes by encouraging other industries to implement tipping practices. Half-jokingly, he gave a hypothetical example of a lawyer who gets paid in tips to avoid having to report client fees on income tax statements. “That would probably raise some eyebrows,” he said. “But you could see an introduction of different norms.”

All three of the Republican bills would cap the maximum tax-free tip amount between $20,000 and $25,000. They also specify that only employees in certain industries like hospitality and cosmetology would qualify for the tax exemption.

But even with added clarifications, some experts think tax-free tip policies won’t help as much as supporters claim.

Joyce Beebe, a fellow in public finance at Rice University’s Baker Institute, said that tax-free tips would disproportionately help certain people but not others within the same wage bracket. A line cook might make the same hourly rate as a waiter, yet only one would receive a tax break. “They will be treated differently by tax code,” explained Beebe. “So there’s a little bit of inequality there.”

Revising the tax code also likely won’t help a significant number of tipped earners. About 37% of tipped workers earn so little that they don’t pay federal income taxes, according to the Budget Lab.

Beebe said that advocates of getting rid of tip tax want to help low-income workers who make below minimum wage. According to the Fair Labor Standards Act, tipped employees must make at least $7.25 per hour. If a worker makes less than that amount, including tips, employers must make up the difference. But many states have a tip credit, meaning employers only have to pay $2.13 as long as tips make up the difference.

Thirty states and the District of Columbia have raised the tipped minimum wage above the federal benchmark. Others such as California and Minnesota pay tipped earners the same amount as regular employees.

In the early 2000s, Nathan Goldman waited tables at Champps Kitchen and Bar in Tucson, Ariz. He made a point of reporting his tips, even when they were paid in cash. Occasionally, he’d often get a paycheck for $0.00. “If you’re getting more than $30 an hour in tips, you just won’t get that $2.13,” said Goldman, now an associate professor of accounting at North Carolina State University.

Goldman believes eliminating tip taxes could pass Congress fairly easily and might raise the incomes of some workers. But addressing the federal subminimum wage would likely be more helpful in the long run, he said: “Just raise that $2.13 instead of making everything else tax-free.”

WORLD’s Leo Briceno contributed to this report.