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To Tax Or Not to Tax: What's the Deal with Tips?
Washington has been full of talk about eliminating taxes on tips. What does that mean? Kopsa Otte's Jaimee Ortegren walks us through the proposed legislation and what it could mean if passed.
by Jaimee Ortegren of Kopsa Otte
March 20, 2025
Kopsa Otte's Jaimee Ortegren outlines the different legislative proposals eliminating taxes on tips and what that means to owners and stylists.
3 min to read
In the past few years there has been a lot of buzz surrounding the topic of taxes on tips. In fact, both presidential candidates in 2024 made it a point to mention the issue while on the campaign trail and the issue remains important on both political party’s agendas.
Before we tell you what they are proposing, let’s talk about what the current rule is. In simple terms, employers are required to report employee tips on their paychecks and pay FICA tax. Employees are required to report their tips to their employer. This is for all tips – no matter how the employee gets the tip. Whether it’s through the credit card machine at the salon, an app that deposits the money to the employee directly or cash/gift they get from a client directly.
All these items are reportable tips; all subject to FICA tax and ordinary income tax, Federal and State if your state has state income tax. Recently, we are aware of two IRS balance due notices issued to salon owners for FICA tax not paid because an employee reported tip income on their personal tax return that they had not reported to the owner. The owner was required to pay back FICA tax. Don’t get caught getting bad advice about tips. They are taxable.
Now let’s get to what all the noise is about right now….
There are several different proposals that have been put out there regarding taxation on tips earned.
No Tax on Tips Act: This bill would exempt all cash tip income from federal income tax. Cash tips would include any given in cash, credit, or debit card transactions. Non-cash tips, such as gifts, tickets, etc., would NOT be exempt from federal income tax.
Tax-Free Tips Act of 2024: This bill would exempt tips from federal income tax as well as payroll tax.
Tipped Income Protection and Support (TIPS) Act: This bill would see the end of the $2.13 hourly minimum wage for tipped workers and eliminate federal income tax on tips.
What is the potential impact?
There are several things that could happen were one of the proposed bills to pass. Obviously the largest would be the fact that there would be a promise of some financial relief for tipped workers. Some other consequences though that might not be so obvious would include:
Less money being put into important federal programs such as social security
Disproportionate benefit for higher earners in the tip workforce
Other industries could turn to the tip method when paying their employees because tips will not be taxed while regular wages will. This could lead to more businesses expecting tips for services provided
Will it be fair?
Some may argue that by not taxing tips there will be an imbalance in the workforce. The following example provided on taxfoundation.org explains this more in depth.
“Consider two individuals: a cashier named Tracy and a waitress named Susan. Tracy and Susan each earn $34,000 in income. Tracy receives all her income in wages, while Susan receives $19,000 in wage income and $15,000 in tips. Under the status quo, they each take the standard deduction and end up paying around $2,100 in taxes.
Under the no-tax-on-tips proposal, Tracy sees no tax cut. However, Susan is able to take the new above-the-line deduction for tip income, reducing her adjusted gross income by $15,000. The deduction reduces Tracy’s taxable income to just $4,400, leaving her to pay only $440 in federal income taxes resulting in a tax cut of more than $1,600.” (Muresianu, 2024)
The Bottom Line
There are obviously pros and cons to each bill and not everyone will like the final outcome, but there could be some major changes in the future to keep an eye on.
*Muresianu, Alex, (2024), Frustrated with Tipping? No Tax on Tips Could Make It Worse (taxfoundation.org)
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