No more tax on tips? Workers welcome the plan, but experts say there are better ways to help
When the manager of a local fried chicken restaurant pulls into the Waffle House parking lot, server and cook Mike Broughton gets to work.
Four to six eggs scrambled. Wheat toast, dry, with strawberry jelly. Hash browns, smothered and peppered.
It’s just one order he’s come to learn of the many familiar faces that come through his doors.
“It's actually fun with them because they know you know them, you know their order,” he said.
That familiarity can also lead to more generous tips, something vitally important to employees like Broughton, who earn tips as part of their income.
And soon, those employees could see a new tax benefit, if campaign trail promises come to fruition.
Proposals to end taxation on tips earned by bartenders, servers, hairdressers, and other tip earners surfaced over the summer when President-elect Donald Trump floated the idea at a swing state rally in Las Vegas, home to one of the highest concentrations of tipped workers in the nation.
Democratic presidential candidate Vice President Kamala Harris also threw her support behind the effort, and several U.S. senators and representatives filed bills that would take the campaign pledge to tax code reality.
“It'll be a blessing if that was to happen," Broughton said. "But really, as far as when it comes down to any type of person that's running for office, I believe them with a grain of salt.”
While the sentiment to help low-wage workers who derive income from the whims of the tipping public resonated on the campaign trail, economists are skeptical of its ability to reach those most in need and concerned about how it may change employer and customer behavior.
“If you want to help low-income workers, this is just not the way to do it,” said William Gale, senior fellow of economic studies at the Brookings Institution, a Washington, D.C.-based public policy organization. “It's not a good way to help low-income workers. It's certainly not a good way to conduct tax policy.”
The plan aims to help tip earners, though reach will be limited
A relatively small slice of U.S. workers routinely receive tips, about 2.5% or about 4 million people, according to an analysis by the Yale Budget Lab. Tips are considered fully taxable income.
The proposal’s reach is expected to be further limited by the fact that about 37% of tip-earning workers already don’t make enough money to owe federal income taxes.
Federal income tax is progressive, meaning those with higher incomes pay a higher tax rate. Those who earn more, in turn, owe more taxes and would see more savings from the proposal.
Generally, those making below the standard deduction on tax returns ($14,600 for single filers and $29,200 for a married couple filing jointly in 2024) don’t owe federal income taxes.
Others who do have a tax liability may have the amount they owe lessened or eliminated thanks to tax credits meant to help lower-wage workers, such as the earned-income tax credit and the child tax credit.
Under the plan, workers would still owe federal income taxes on their base hourly wage but wouldn’t be taxed on whatever tips they bring in, be those via cash, card or check.
The Yale Budget Lab estimates the average tax cut for families affected by the change would be about $1,700, though those in the bottom fifth of earners would see a $200 average cut.
Ending income tax on tips would be a welcome change for Dee Thornton, who has worked in the Louisville restaurant industry as a server for the past six years and doesn’t think they should have been taxed.
“I feel like tips should be considered a gratitude,” Thornton, 28, said. “I just don't feel like it makes sense to tax money that's not consistent.”
Emily Litzinger, a partner in the Louisville office of national labor and employment law firm Fisher Phillips, said the policy stands to help both employers and employees, though its reach may be limited and its repercussions on the employer and consumer behavior are still unknown.
"The goal is to help low-wage earners and the service-oriented roles so they can take home more money, and that arguably in turn will ease that labor cost for restaurateurs or hospitality employers that are dealing with inflation, low margins for profit, rising food costs, all that stuff," she said.
What about payroll taxes?
For Ryan Hughes-Svab, who along with their husband, Martin Svab, owns and operates The Misfit Lou restaurant and bar in downtown Louisville, there are mixed feelings about the proposal and many questions as to how it would be implemented.
Will it end only the federal income tax? Would it be limited to only certain industries? Would there be an income cap?
Tips can make up a significant portion of a worker’s income, especially if they are making a base wage at or below the federal minimum wage of $7.25 hourly.
Employers can pay tipped employees an hourly wage as low as $2.13 using what’s called a “tip credit,” assuming tips make up the difference. If tips don’t, an employer would then need to make up the rest.
“I think it could benefit a lot of people,” Hughes-Svab said of the policy proposal. “But I also do think when you look at the negative side of it, there could be some of these repercussions. There's the overtipped culture, and then … bigger companies that are like, ‘Oh, we can save money by paying people less and using this bonus.’”
Should a change in the tax code happen, the small business owners said it would be important that employees still be able to record their tips as income, which Hughes-Svab said was helpful to her when securing a loan to buy a house.
As the American Enterprise Institute, a Washington, D.C.-based public policy think tank, noted in an August policy brief, not counting tips as income could mean a worker qualifies for less in tax credits, such as the earned income tax credit, which is tied to how much income a person reports.
Hughes-Svab and Svab said they would also want to see employee contributions continue toward Medicare and Social Security so those benefits aren’t reduced when employees are older.
Various bills filed in Congress since Trump first announced his plans are more alike than not, but among the differences is the handling of payroll taxes, including FICA, which helps fund Medicare and Social Security.
Under legislation introduced by Sen. Ted Cruz, R-Texas, workers would still owe payroll taxes but their tips would be exempt from income tax via a tax deduction. Another plan from Rep. Thomas Massie, R-Ky., would additionally exempt tips from payroll taxes.
The National Restaurant Association, which backs the end to income tax on tips, is in support of payroll taxation staying in place, saying in a policy brief that “employees must demonstrate income to build credit and pay into Social Security and unemployment benefits through FICA contributions.”
Policy raises issues of reach, fairness
Giving a tax benefit to one type of work over another isn’t sound tax policy, according to the Brookings Institution's Gale, as the tip-focused proposal inherently creates a special tax benefit for a slim segment of the workforce.
Take, for example, a grocery store worker who makes $30,000 annually and a restaurant server making $10,000 in hourly wages and $20,000 in tips. Despite making the same amount of money, the grocery worker would end up paying more in taxes.
“That's exactly the issue: people who are in similar circumstances but are treated differently,” Gale said. “Other people who receive income in other forms are going to say, ‘Well, why not us, too?’”
Median earnings for wait staff in the U.S. is about $32,000 a year, or $15.36 an hour, according to the U.S. Bureau of Labor Statistics for 2023.
Of the nation’s lowest-income workers, about 5% or 6% would be affected by the tipping proposal, an analysis by the Yale Budget Lab found.
"It'll help some people, but those people would be relatively high earners that earn tips," Gale said. "And why, if you want to help low-income, low earners, why would you choose a form of compensation that only 5% of them get?"
Employers, meanwhile, are concerned about how a policy benefiting only tipped workers will play out in workplaces where tipped and nontipped employees work side by side, Litzinger said, such as in a restaurant where servers earn tips while cooks do not.
“I think that there's sort of overarching concern from an employer standpoint about employee morale,” said Litzinger, the labor and employment lawyer, who also serves as a member of the Kentucky Restaurant Association board of directors.
“I think there is a concern that if these people in the front of the house are exempt from having taxes on their tips, which is a large portion of what they're taking home, if that puts them at odds with the back of the house and how to kind of work through that potential conflict between your workforce.”
Economists worry about unintended consequences, abuse of the exemption
While intended to help put money back in the pockets of some of America’s workforce, the idea could have negative repercussions, some economists and tax policy experts warn.
One concern is over how the change may encourage more employers to adopt tipping in positions where it doesn’t already exist to take advantage of tax-free tips, and in doing so, pass along labor costs to the tipping public.
More tipping screens in front of consumers' faces, meanwhile, is a concern for employers, who don’t want consumers’ tip fatigue to worsen and affect their employees’ tips.
Another question is how consumers’ tipping behavior might change if more employers move toward a tip-based system. A Pew Research Center survey in 2023 found about three-quarters of respondents felt tips were expected in more places than five years ago.
“After the pandemic, we saw a lot of uptick of tipping, and it's everywhere. And will this create more blow-back from the consumer, will this create a push or an increase in the tipping culture?” Litzinger asked. “And how does that pan out from a consumer standpoint?”
Gale also noted the potential for high-wage earners in industries that don’t currently have tipping to exploit the system by reclassifying earnings as tipped income.
“Could people who are traditionally not tipped, could they start kind of pushing to have tips?” Litzinger asked. “I'm not sure. I don't know how far it will go.”
Some economists argue that pursuing a taxation exemption will take the focus off more broad measures of helping low-wage earners, including the expansion of certain tax credits for low-income workers, elimination of the subminimum wage of $2.13, and raising of the $7.25 minimum wage.
On the flip side, untaxed tips could make tip-based positions more attractive, increasing the labor pool for those jobs and making hiring and retention easier for employers, Litzinger said.
The proposal may be attractive to employers for financial reasons, too.
“I think it will ultimately ease the burden of the labor cost,” she said. “A lot of operators have really tight margins. So, I think that there are operators that are in favor of it for that reason, that that may be a benefit to them.”
As for its cost to the federal government, eliminating both income and payroll taxation on tips would reduce federal revenue by $150 billion to $250 billion over the next decade, according to nonpartisan fiscal watchdog group The Committee for a Responsible Federal Budget.
Another estimate by Washington, D.C.-based tax policy think tank Tax Foundation puts the figure at $107 billion over 10 years if only income taxes are eliminated.
Where the proposal stands
Since being introduced over the summer, bills in Congress have not advanced.
Meanwhile, tax experts anticipate that if the legislative branch is going to consider the tip idea, it will do so next year alongside other tax policy issues, including the upcoming expiration of 2017’s Tax Cuts and Jobs Act and other tax-related Trump tax policy ideas, such as eliminating taxes on overtime and Social Security.
“This is going to get folded into tax policy at large, and there's a huge number of moving parts in the tax debate and how this one plays out would depend on how all the others play out,” Gale said.
Until those debates play out in the nation's capital, Broughton will keep the orders coming at the Louisville Waffle House ... and his customers’ coffee cups full.