Workers in the U.S. who rely on tips have seen some significant tax changes after Congress approved a new law that aligns with President Trump’s agenda. Recently, the Republican-controlled Senate and House passed a substantial spending and tax package. This legislation establishes temporary tax exemptions related to tips that could influence other tax cuts as well.
Once the new provisions kick in, individuals can deduct up to $25,000 in tips from their taxable income each year, though these tips will still be subject to federal taxes.
Garrett Watson from the Tax Foundation, which supports simplifying tax regulations for economic growth, remarked, “It’s a pretty generous deal for a lot of workers.” However, if a worker’s income exceeds $150,000 annually, their additional income will start to be taxed.
Watson pointed out that this approach might help prevent high earners from manipulating their income to classify it as tips inappropriately. Tax professionals were concerned that hedge fund managers and lawyers would exploit the system to shift their federal taxes onto “tipped workers.” The legislation also imposes limits on tax-free tips for certain professions that routinely receive tips, although it doesn’t clearly define those jobs.
“Ultimately, it will be up to the Treasury and the IRS to interpret this language,” Watson added.
The law is set to phase out by the end of 2028 unless Congress decides to extend it.
Political Promises Kept
Trump made strides towards a “no tax on tips” policy as he heads into the 2024 presidential election. Back in June, he mentioned that the idea came from a tip worker in Las Vegas. By August, Kamala Harris was also campaigning for the elimination of tip taxes.
As the bill approaches the president’s desk, tipped workers might see a reduction in their federal taxes “later this year,” depending on how quickly the IRS and Treasury act.
“As we move into the next season, people will notice adjustments to that tax and potential rebates for withholding from income,” Watson noted.
The no-tax-on-tips idea has garnered bipartisan support, with contributions from Senator Ted Cruz and Representative Vern Buchanan among others.
Yet, Congressional Democrats expressed universal opposition to the package, mainly due to proposed cuts to Medicaid, which could leave over 10 million Americans without health insurance over the next decade.
“There’s no denying the suffering caused by this,” said Representative Horsford, emphasizing that this is a reverse Robin Hood scenario. He warned Republicans that they won’t have the last word—Americans will speak on Election Day.
On Monday, Horsford proposed an amendment to exempt permanent tips from taxation, but it did not pass.
Buchanan, on the other hand, celebrated the bill’s passage, calling it a “big, beautiful law” that fulfills promises made.
Implications for Americans
While some are controlling the narrative from the White House, Martha Guin Bell, a former Biden administration official, expressed skepticism about the law’s substantial impact on most American workers or wages. “Overall, tipped jobs make up a small portion of the labor market—around 2.5%,” she pointed out.
She also mentioned that low-income workers generally wouldn’t feel much change, as they usually have little to no taxable income. “The majority of the benefits will likely go to workers in the middle-income bracket,” she added.
To illustrate, she suggested that a hairstylist might see lower prices for haircuts, but they could also expect to receive higher tips.
Gimbel advised looking at the bigger picture regarding the bill. “Our analysis shows that if you earn over $3.3 million, you could receive a tax cut exceeding $118,000, while those in the lowest income group may lose around $560 due to cuts in food stamps and Medicaid,” she explained.
“This is a regressive bill that will carry high costs,” she concluded.
What Should Tipped Workers Do Now?
Watson believes it’s essential for workers to wait for further guidance from the IRS and Treasury. Once new direction is given, tipped workers can adjust their W-4 forms to reflect these new tax exemptions. Alternatively, they could wait for a refund when filing their taxes in the spring.
“Many will likely use tax software to navigate this, and it should be integrated quickly into next year’s filing season,” Watson stated. “But caution is always recommended to ensure everything is correctly understood.”
He also cautioned that many tipped workers hold multiple jobs and reminded them that only $25,000 in tips is tax-free annually.
