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1 [1] (May 29, 2025)

handle is hein.crs/txnotpince0001 and id is 1 raw text is: Congressional Research Servce Inforning the legislative debate since 1914 Updated May 29, 2025 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 are considering making some tip income exempt from the individual income tax, and have introduced other proposals to exempt such income from payroll taxes. This In Focus explores the tax treatment of tips and the potential consequences of exempting tip income from taxation. Current-Law Treatment of Tips Payroll 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 ($76,100 in 2025) 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). Withholding and Reporting 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 Tipped Workforce 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. 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 Exclusion from Tax Lawmakers have introduced legislation in the 119th Congress to exempt tip income from some or all income and payroll taxation. As passed by the House, Section 110101 of H.R. 1, the One Big Beautiful Bill Act, would create a new income tax deduction for qualified tip income for tax years 2025 through 2028, which could be claimed in addition to the standard deduction. Qualifying tips could include those received in non-employee arrangements (such as independent contracting), and would be limited to those in occupations that traditionally receive tips and that are paid voluntarily, without negotiation. Taxpayers could not claim the deduction if they receive earned income in excess of the highly compensated employee threshold ($160,000 in 2025) or if they work in a specified service trade or business for purposes of the qualified business income deduction. Workers would still report tips as part of their ittps://Crsreports.congress.gt

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