Recent legislative changes in the U.S. could bring substantial tax relief for tipped workers. On Thursday, Congress approved a key component of President Trump's legislative agenda, leading to the passage of the One Big Beautiful Bill Act. This comprehensive spending and tax package includes temporary tax exemptions specifically for tips, among other tax benefits.
Under the new law, effective once the provision is implemented, workers will have the ability to deduct up to $25,000 in tips from their annual taxable income. Beyond this threshold, any tips will be subject to federal taxation. According to Garrett Watson from the Tax Foundation, this change is expected to benefit a significant number of individuals earning tips across the United States, as it addresses the majority of tipped income earners.
However, it's important to note that workers with an income exceeding $150,000 per year will see their tipped income taxed, which aims to prevent high earners from misclassifying their income as tips to evade federal taxes. Watson expressed concerns that high-income individuals, such as hedge fund managers and lawyers, might attempt to recharacterize their earnings as tips, a scenario the legislation seeks to mitigate.
The new package stipulates that tax-free tips will apply only to workers in occupations that customarily receive tips; however, the law does not specify which jobs are included. It will be the responsibility of the Treasury Department and the IRS to define these roles, as noted by Watson.
If Congress does not extend the law, it will gradually phase out by the end of 2028, coinciding with the conclusion of Trump's presidency. This provision reflects a political promise made during his campaign, where Trump emphasized the significance of eliminating taxes on tips.
The no-tax-on-tips initiative garnered bipartisan backing from several congressional members, including Sen. Ted Cruz, R-Texas, and Rep. Vern Buchanan, R-Fla. Nonetheless, the overall package faced opposition from Democrats, who raised concerns regarding cuts to Medicaid. Critics argue that the legislation could lead to over ten million Americans losing health insurance over the next decade. Rep. Steven Horsford, D-Nev., labeled the bill as “Robin Hood in reverse,” highlighting the potential negative impact on vulnerable populations.
Despite the high-profile nature of the no-tax-on-tips policy, some experts, such as Martha Gimbel from the Yale Budget Lab, question its overall impact on American workers. Gimbel notes that tipped work represents only about 2.5 percent of the labor market and suggests that the policy will primarily benefit middle to upper-middle-income workers.
For instance, she points out that while hairdressers might lower haircut prices with the expectation of increased tips, the broader effects of the legislation should be evaluated in context. Gimbel argues that higher-income individuals will receive significant tax cuts, while low-income Americans may face losses due to cuts in programs like SNAP and Medicaid.
As the IRS and Treasury Department prepare to release further guidance, tipped workers are advised to stay informed. Watson suggests that workers should consider updating their W-4 withholdings to reflect the new tax-exempt status for tips. Alternatively, they may choose to wait for potential refunds when filing their taxes in the spring. Many workers in tipped positions often hold multiple jobs, so it is crucial to remember that only $25,000 of tips will be exempt from taxes, regardless of how many tipped jobs they have.
As these changes unfold, staying updated and proactive will be essential for tipped workers navigating the new tax landscape.
