The House has passed a new bill that aims to cut taxes, slash spending, and raise the debt limit. The bill includes a proposal to cut federal income taxes on tips. The Senate has already voted unanimously in favor of the measure.
If enacted, the tax change will be effective from 2026 to 2028. Under current federal tax law, all tips must be reported as taxable income. This includes tips provided as cash, via credit or debit cards, or through electronic payment systems.
Both employees and employers are required to track and report every cent. The proposed bill aims to make tip income exempt from federal income taxes. This means the amount earned in tips would be subtracted from reported income as an “above the line” deduction on tax returns, thus reducing the amount of taxable income.
However, tips will still need to be tracked and reported. There is an ongoing debate about who will benefit from this measure. The bill applies to all tipped workers in the restaurant industry, including servers, baristas, food delivery drivers, and anyone offering a payment screen after a food sale.
According to industry figures, there are over two million tipped restaurant workers in the United States.
Bills targets federal income tax on tips
Several restrictions might apply to who qualifies for the deduction, though these could change:
1. Highly compensated employees or those who own 5% or more of their business do not qualify.
2. The claimant must have a Social Security number, meaning they must be an American citizen or have a permit to work in the U.S. If filing jointly, the spouse must also have a Social Security number.
3. The claimant must work in an occupation “which traditionally and customarily” has received tips. The Senate’s version of the bill includes a $25,000 deduction cap, whereas the House legislation does not mention a cap.
The House proposal would extend the break through 2028, while the Senate version doesn’t include an expiration. A nonpartisan watchdog group in Washington estimates the tax break on tips could reduce federal revenues by $40 billion between now and 2028. The Council of Economic Advisers estimates the average take-home pay for tipped workers would increase by $1,675 per year.
However, because 40% of tipped workers earn too little to pay federal income taxes, they wouldn’t benefit from this provision. There is also concern that some employers might reclassify workers as tipped to take advantage of the tax break. Advocacy group One Fair Wage criticized the bill, noting it includes cuts to social safety net programs that many tipped workers rely on, such as Medicaid.
As the bill continues to make its way through Congress, its final form and the specifics of its implementation will be closely watched by all stakeholders involved.