Promise Kept on Tipped Income?
With the signing of the Budget Bill, persons working at “an occupation which customarily and regularly receive tips” can deduct up to $25,000 of tip income provided their total income does not exceed $150,000. This deduction will be phased out beginning in 2028 unless extended by Congress. Trump made three promises to reduce taxes to three distinct groups during the campaign–tipped workers, overtime workers and social security recipients. Harris only campaigned on tipped workers likely because of its importance in the battleground state of Nevada. In the end it did not work out for her in Nevada because of the general drop off in support from Hispanic voters, but apart from pandering to voter blocks, is there anything different about tipped income than social security payments and overtime pay? Arguably yes.
The Internal Revenue Code generally does not tax gifts as income, but does tax the gratuities paid as tips. This is due to the employers of tipped workers using tips as a substitute for wages. This started after the Civil War when the service industries would use African American women in their businesses, pay them nothing, but allow them to keep some or all of the tips they received. The first federal minimum wage legislation–25 cents an hour–as part of the Fair Labor Standards Act of 1938 excluded restaurant employees (and agriculture and other service occupations) and it was not until 1966 that restaurant workers were included. Even then employers could pay a much lower minimum wage to tipped employees. In 2009 the federal minimum wage was $2.13 for tipped workers with the employer being required to gross up the wage to the general minimum wage of $7.25 an hour if tip income did not do so. In practice, few employers comply although given the post pandemic world with labor shortages and the effect of state laws, it is questionable how many documented working people get paid less than $7.25 an hour today. FICA payments are due on tips and although historically tips were under reported by all concerned, the transition to an almost cashless society has reduced non reporting. Because the Budget Bill allows for the deduction only from declared tips, there will be less incentive to under report even cash tips.
Presumably, the temporary deduction for tipped income will have little impact on the economy. By some estimates only about 2 and a half percent of employees are in tipped occupations and to the extent that those employees are poorly paid in total they never paid much income tax on tips in the first place. At the high end, a few may exceed the $150,000 income cap. For a single worker who has taxable income of $50,000 comprising $25,000 in regular wages and $25,000 in tip income, the federal tax savings would be about $3000.
The interesting questions that remain are how both employees and employers will try and game the system going forward, whether those states that have an income tax will go along ( States that rely on sales taxes have always lost out with tips because the sales tax does not apply to them) and whether this change in the law will have any effect on tipping culture in this country.
The Internal Revenue Code generally does not tax gifts as income, but does tax the gratuities paid as tips. This is due to the employers of tipped workers using tips as a substitute for wages. This started after the Civil War when the service industries would use African American women in their businesses, pay them nothing, but allow them to keep some or all of the tips they received. The first federal minimum wage legislation–25 cents an hour–as part of the Fair Labor Standards Act of 1938 excluded restaurant employees (and agriculture and other service occupations) and it was not until 1966 that restaurant workers were included. Even then employers could pay a much lower minimum wage to tipped employees. In 2009 the federal minimum wage was $2.13 for tipped workers with the employer being required to gross up the wage to the general minimum wage of $7.25 an hour if tip income did not do so. In practice, few employers comply although given the post pandemic world with labor shortages and the effect of state laws, it is questionable how many documented working people get paid less than $7.25 an hour today. FICA payments are due on tips and although historically tips were under reported by all concerned, the transition to an almost cashless society has reduced non reporting. Because the Budget Bill allows for the deduction only from declared tips, there will be less incentive to under report even cash tips.
Presumably, the temporary deduction for tipped income will have little impact on the economy. By some estimates only about 2 and a half percent of employees are in tipped occupations and to the extent that those employees are poorly paid in total they never paid much income tax on tips in the first place. At the high end, a few may exceed the $150,000 income cap. For a single worker who has taxable income of $50,000 comprising $25,000 in regular wages and $25,000 in tip income, the federal tax savings would be about $3000.
The interesting questions that remain are how both employees and employers will try and game the system going forward, whether those states that have an income tax will go along ( States that rely on sales taxes have always lost out with tips because the sales tax does not apply to them) and whether this change in the law will have any effect on tipping culture in this country.
Terry:
Nice commentary for a new AB writer. Kind of confused with this comment at the end:
“interesting questions that remain are how both employees and employers will try and game the system going forward, whether those states that have an income tax will go along ( States that rely on sales taxes have always lost out with tips because the sales tax does not apply to them)”
You did get a number of views.
I am not sure I agree with this: “Because the Budget Bill allows for the deduction only from declared tips, there will be less incentive to under report even cash tips.” Would not declaring and then deducting result in a net zero to taxable income? And if cash tips are over $25K, not declaring them would mean zero taxability for the whole amount not just part.
Being old and set in my ways, I always tip in cash even if I charge the meal. How the server reports it is up to them. Not that I would countenance underreporting income, of course.
Jane:
Ditto on the cash tips and we do tip more if we know the wait staff (those who served us before). I like when people do better in life. It is a hard job and so much depends on the nature of the food (good or bad) and the interaction with people.
I see many of them as maybe college students and others on the opposite end. Both to whom we could have an impact.