Don't Mess With Taxes

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Congressional proposals to exempt gratuities from income pop up periodically, usually in election years. It’s happening again in 2024.

Republican presidential nominee Donald J. Trump suggested tax-free tips during a June campaign stop in Nevada, where workers in tourist meccas like Las Vegas depend on the added income.

Vice President Kamala Harris, the Democratic counterpart hoping to hold the White House for the party, endorsed easing taxes on tips in August.

So, of course, lawmakers on Capitol Hill got in on the tax-free pledge.

So far, bills to exempt tip income have been introduced in the House by Rep. Don Bacon (R-Nebraska), H.R. 7870, the Tip Tax Termination Act; Rep. Byron Donalds (R-Florida), H.R. 8941, the No Tax on Tips Act; and Rep. Thomas Massie (R-Kentucky), H.R.8785, the Tax Free Tips Act of 2024. In the Senate, Texas Republican Ted Cruz introduced S. 4621, the No Tax on Tips Act.

Now a Democrat has joined the no-tip-taxation legislative group.

TIPS Act introduced: Rep. Steven Horsford announced his Tipped Income Protection and Support (TIPS) Act on Sept. 17 on the U.S. Capitol grounds with members of the One Free Wage organization cheering the move.

“Today, I am proud to be introducing a bill because a disproportionate number of the 6 million tipped workers who are women and people of color make as little as $2.13 an hour, which really is poverty wages, at a time when families and workers are trying to afford the cost of living,” said the Nevada Democrat, who is a member of the House Ways and Means Committee.

That $2.13 per hour wage is allowed under current federal law to be paid tipped workers, primarily restaurant employees, as long as they get customer tips to bring their earnings to minimum wage requirements.

In a press release announcing the TIPS Act, Horsford noted that more than  4 million tipped workers nationwide “rely on this precarious wage system.” The representative’s state, however, is not among them. Nevada is among the handful of states that have abolished the subminimum wage for tipped workers, applying the minimum wage to all Silver State workers.

“Studies show that when workers are paid a fair wage, they experience less financial stress, leading to higher quality service and improved overall workplace morale,” said Horsford in the release.

“In Nevada, where the minimum wage applies to all workers, restaurants have seen an increase in productivity, employee retention, and customer satisfaction,” added Horsford, noting that “fair wages do not harm the restaurant industry—in fact, they lead to long-term success.”

Implications of tax-free tips: In addition to being the only legislative proposal by a Democrat, the TIPS Act is the most detailed in how the tax exemption for tip income would work. It includes provisions setting an income threshold of $112,500; a limitation to the food service, hospitality, cosmetology, and custodial services industries; and the elimination of the tipped workers minimum cash wage.

The Budget Lab, a nonpartisan research center at Yale University, has examined some of the tip tax exemption bills introduced by Horsford’s GOP colleagues. Its analysis found that the impact of the Cruz and Donalds proposals would be minimal, largely because many workers whose jobs include gratuities already don’t pay federal income tax because they don’t earn enough to require they file.

The study also looked at potential costs. An income tax deduction for tips, for example, would cost more than $100 billion over the next decade, according to The Budget Lab study. However, restricting eligibility to workers in the leisure and hospitality industries would reduce the cost by more than 40 percent.

And The Budget Lab pointed out a broader issue with delineating income sources for tax benefits.

“A tax break that favors one form of income over others creates opportunities for tax avoidance,” according the report. “Back-of-the-envelope calculations suggest that the true cost of the proposal would be larger than the static cost, though the exact amount depends on the willingness of customers to trade lower prices for higher tips.”

The Tax Policy Center also provides a look at how federal no-tax-on-tips legs could affect states. Notably, there’s the question as to who would benefit and how that varies by state, write Nikhita Airi and Lillian Hunter in a post for the nonprofit’s TaxVox blog.

“Tipped workers make up different shares of each state’s labor force, and each state has different rules for paying tipped workers. And in 41 states with income taxes, legislatures would need to decide whether to exempt tips from state income taxes if Congress enacted a federal tip exemption,” say Airi and Hunter.

Possibility of passage: Although there are several bills to exempt tips from federal taxes, whether any will make it into law this year is unlikely.

Obviously, nothing is going to happen before Nov. 5. The results of the presidential race then will determine the type of tax-free tips measure and how quickly it will move through the legislative process.

A lame-duck Congress will have other year-end matters to consider. It's more likely any tips bill will be considered in 2025, by a new Congress and President. It could be part of the conversation next year when the House and Senate deal with expiring Tax Cuts and Jobs Act provisions.

You also might find these items of interest:

• Reporting holiday and year-round taxable tip income
• Restaurant tips rule change that could short-change wait staff is scuttled
• Tax-free tips might not actually help intended workers, and could increase the U.S. deficit

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