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1 1 (July 31, 2024)

handle is hein.crs/goveqeo0001 and id is 1 raw text is: Congressional Research Service informing the legislative debate since 1914 July 31, 2024 Taxation of Tip Income Federal law generally requires workers to pay individual income taxes and the payroll taxes on their tip income, as on other compensation. Lawmakers have introduced several bills in the 118th Congress to exclude tip income from the individual income tax, and in some cases, from payroll taxes. This In Focus explores the tax treatment of tips and the potential consequences of excluding tip income from taxation. Current-aw Treatment of Tips Payro Taxes Tips are generally considered wages for payroll tax purposes. Federal payroll taxes include taxes on both the employee and employer of 6.2% of a worker's wages up to a taxable maximum ($168,600 in 2024) to finance the Social Security trust funds, as well as of 1.45% of a worker's wages to finance the Medicare Hospital Insurance trust fund; these taxes are commonly referred to as Federal Insurance Contribution Act (FICA) taxes. Individuals also pay an Additional Medicare Tax of 0.9% on compensation exceeding $200,000 ($250,000 for couples married filing jointly; $125,000 if married filing separately). The Tax Policy Center estimates that roughly 67% of households with incomes below $100,000 in 2023 paid or generated more in payroll taxes than in individual income taxes, including both the employer- and employee-side taxes. Employers must pay the employer portion of payroll taxes on tips that their employees receive. Food and beverage businesses at which tipping is customary can receive a credit against their income tax liability for FICA taxes paid on tips exceeding the amount needed to meet a wage of $5.15 per hour for each tipped employee. Employers also pay a Federal Unemployment Tax Act payroll tax. This tax is usually worth 0.6% (net of credits for state unemployment taxes) on each employee's first $7,000 earned, including tips. Employers (and employees, in some states) also pay state unemployment insurance taxes, the rules for which differ by state. Income Tax The individual income tax applies to all income from whatever source derived unless excluded by law. The tax applies to tips, including cash tips not reported to an employer. Tips that are part of a taxpayer's gross income are considered earned income. Earned income is important for calculating the earned income tax credit (EITC) and the refundable portion of the child tax credit, known as the additional child tax credit (ACTC). Withho ding and Report ng Tips Workers must report tips exceeding $20 per month to their employers, who must in turn withhold FICA taxes on them when possible and report the tips to the Internal Revenue Service (IRS). Businesses must include tips received by their workers as part of gross receipts when filing their own taxes, but can deduct them as employee compensation. Food or beverage establishments with 10 or more employees at which tipping is customary may have to allocate tips to employees. Tips are allocated to employees if their reported tips are below their share of 8% of food and drink sales. Even with this backstop, the IRS has said that the lack of complete information reporting and the cash nature of many tips suggest that tip income has a lower compliance rate than other wages and salaries and is harder to detect during an audit. The Tpped orkforce The IRS reports that in 2018 (the most recent year available) roughly $38 billion in tips were reported on the W-2s associated with 6 million income tax returns. While the average tipped income reported on W-2s in that year was roughly $6,000, the median among tipped workers was about $2,600. This suggests that (reported) tip income is relatively concentrated among a subset of tipped workers. The Budget Lab at Yale University estimates that fewer workers, roughly 4 million, worked in tipped occupations in 2023 based on Census Bureau data. Workers in tipped jobs were disproportionately lower earners. While tipped workers comprised 2.5% of total employment, they made up 4% of employment in jobs earning below $25 per hour (i.e., the bottom half of the hourly wage distribution) and 5% of those earning below $17.66 per hour (bottom quarter). The estimated median weekly wage for tipped workers was $538 (including tips), compared to roughly $1,000 for nontipped workers. The Budget Lab also estimated that 37% of tipped workers had too little income in 2022 to pay income tax before accounting for tax credits. This suggests a relatively large share had no or little income tax liability. Most such workers still likely paid payroll taxes. Proposals for Ex usion from Tax Lawmakers have introduced legislation in the 118th Congress to exclude tip income from some or all income and payroll taxation. S. 4621, the No Tax on Tips Act, would let taxpayers deduct cash tips reported to their employers from income subject to the individual income tax. As an above-the-line deduction, taxpayers could claim this deduction even if they also claimed the standard deduction. Workers would still report tips as part of their gross income and would owe payroll taxes on tips. H.R. 8785, the Tax Free Tips Act, would classify tips as gifts and thus exclude them from workers' gross incomes

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