The bipartisan bill, which received unanimous approval from the U.S. Senate on May 20, could potentially impose income taxes on tips given to bartenders and restaurant employees, among others who rely on customer satisfaction for their earnings.
This legislation, highlighted by Texas Republican Sen. Ted Cruz back in January, is co-sponsored by several senators, including Democrats Jackie Rosen and Catherine Cortez Masto from Nevada. The bill aligns with President Donald Trump’s campaign promise to eliminate taxes on tips that form a substantial part of workers’ income.
Once the bill moves to Congress and is signed into law by President Trump, there are resources outlining how this law might impact workers in the restaurant industry and those who depend on tips for their livelihood.
What do taxes on tips mean?
The proposal suggests that tip income could be exempt from federal income taxes—and possibly payroll taxes as well—while introducing new tax credits up to $25,000 for certain workers. For instance, if a bartender makes $70,000 a year and $25,000 comes from cash tips, they’d only be taxed on $45,000 for their federal income tax obligations.
However, there are restrictions; employees earning over $160,000 by 2025 won’t be eligible for this tip tax credit. Also, the deduction applies exclusively to those in roles where tips are “conventionally” received.
The bill looks to broaden business tax credits associated with payroll taxes for employers based on certain tips. This includes payroll taxes for those in industries such as beauty services, covering barbers, hair care, nail care, and spa treatments.
When will taxes on tips begin?
The proposed law does not have an official start date yet since it still needs approval from the House and President Trump’s signature to be enacted.
This no-tip-tax bill could either stand alone or become part of a broader legislative package related to Trump’s agenda that has yet to be passed. Sen. Cruz expressed confidence that it will either pass independently or as part of another effort, stating that it aims to provide real relief to hardworking Americans. He commended both parties for agreeing on this practical policy despite political divisions.
Who might not benefit from tax relief on tips?
Bartenders and restaurant employees are likely to be the most significant beneficiaries of this potential legislation, considering their income heavily depends on tips.
Yet, it’s worth noting that this only affects a small fraction of the overall U.S. workforce. Estimates suggest that in 2023, a mere 2.5% of American workers were in “tipped jobs” such as bartending or hairdressing, with less than 4% of low-wage workers earning below $25 per hour.
Many in these roles even fall below the threshold for federal income tax. Just last year, about 37% of these workers didn’t incur federal income tax, primarily due to low earnings, according to research.
The average annual tax reduction for these workers could be around $1,800, translating to about $35 each year.
The National Restaurant Association has expressed support for the bill, stating that removing tax burdens could significantly assist workers in the food service industry. Sean Kennedy, a spokesperson for the association, mentioned that this bill is a well-designed initiative that includes improvements to ensure employees are treated fairly while also emphasizing the financial responsibilities of workers.
Over 2 million servers and bartenders are employed in the restaurant business in the U.S., according to the association.
What are the potential drawbacks of a tax-free tip?
Passing this bill might lead to reduced customer tips, especially amid growing consumer fatigue on the matter.
Additionally, restaurant owners could become reluctant to raise base wages, believing that a larger portion of their employees’ income would come from tips, benefitting the owners in the process.
Under federal law, the minimum wage for tipped employees stands at $2.13 an hour, although 30 states have laws requiring higher wages for tipped employees. Some places, like Arkansas and Oklahoma, still maintain low minimum wages below $3 per hour.
Employers might also be inclined to push customers to tip more, as it could help categorize employees as tipped workers. As per the current regulations, employees must report any tips exceeding $20 a month to their employers.
Enacting this bill means that the federal government could potentially collect less tax during a time of considerable budget deficits.
Do I still need to report some tips?
Yes, workers in the restaurant industry and others in similar roles are still expected to report all income, including tips, to both state and federal tax authorities.
