No Tax on Tips: House Passes Bill Exempting Gratuities from Federal Income Tax

Strategic Insights -

A new provision in the domestic spending bill approved by the House aims to give tipped workers a tax break on gratuities, following through on a vow made by President Trump and former Vice President Kamala Harris. The Senate has already voted unanimously for a No Tax on Tips measure, but the bill faces changes before it reaches Mr. Trump's desk. The change will make tip income exempt from federal income taxes, effective from 2026 to 2028, which will put more money in the pockets of tipped workers.

Key Takeaways:

  • The federal tax code requires that every tip be reported as income, whether employees keep the tips or the money is pooled and redistributed.
  • The bill makes tip income exempt from federal income taxes, which will be subtracted from reported income as an "above the line" deduction on a tax return.
  • The tips will still have to be tracked and reported, and employees will be able to deduct tips unless they earn more than $160,000 in a year.
  • The change does not affect the tipped minimum wage, which is $7.25 per hour, or the amount employers pay tipped workers, which is $2.13 if the tips bring the total up to minimum wage.
  • The bill will make the change effective from 2026 to 2028, and will apply to all tipped workers in the restaurant business, including not only servers but also baristas, food delivery drivers, and anyone holding out a payment screen after they have sold food.
  • According to government data, there are more than two million tipped restaurant workers in the United States.
  • The measure applies only to employees who are "customarily" tipped, to be determined by the Treasury Department.
  • Tipping in cash does not make a difference for tax purposes, but reduces a restaurant's credit card processing fees; however, it doesn't leave a paper trail, which can increase the risk of tax fraud.
  • The bill will not change who receives tips or how they are distributed.
  • The change will not affect federal rules that prevent kitchen workers from receiving tips, which are called "back-of-house employees".
  • Tips will continue to count as payroll for federal tax purposes, and employers will still have to withhold employee contributions for Medicare, Social Security (FICA), and unemployment.
  • Employers of tipped workers will continue to get a tip credit, which helps employers reduce their tax bill.

Statistics:

  • Over two million tipped restaurant workers are in the United States (Source: Government data).
  • The federal minimum wage is $7.25 per hour (Source: Government data).
  • The amount employers pay tipped workers is $2.13 if the tips bring the total up to minimum wage (Source: Government data).
  • The amount employees can earn before being subject to the tip deduction is $160,000 per year (Source: Article).
  • The change will make tip income exempt from federal income taxes, effective from 2026 to 2028 (Source: Article).
  • Credit card processing fees are about 2% to 3.5% of each transaction, and sometimes a 30-cent "swipe" fee (Source: Article).

Sources:

  • Government data
  • The domestic spending bill approved by the House
  • The Senate's No Tax on Tips measure
  • The Article in The New York Times