Ready for a Hot Tip? Tipping is the Topic Du Jour this Election Cycle
Have you embraced tipping for takeout? Or do you prefer to just slink out after picking up your grub? As technology has made it easier for the service industry to guide consumer tipping practices, the question of “How much?” is front and center with every transaction.
Now, when you go to the polls this November, tips will also be on the “menu.” Voters in Massachusetts and Arizona will weigh in on state ballot measures that will likely alter the earnings structure of tipped employees in those states. Meanwhile, headline-generating presidential campaign promises could impact employees across the nation. Regardless, this election cycle, it seems we’ve reached a tipping point.
The Federal Landscape: Taxing Tips
The IRS has long regarded tips as taxable income. Historically, however, tips were rarely taxed because they were rarely reported. In the early 1980s, the IRS estimated that a whopping 84% of tips never found their way onto tax returns. But all that changed in 1982 when then-Sen. Bob Dole (R-Kansas), who was on the Senate Finance Committee, championed a bill that cracked down on this practice. When it passed, the Tax Equity and Fiscal Responsibility Act (TEFRA) forced employees to report their tips and for employers to ensure their staff comply with said reporting.
Fast forward to 2024. In a rare instance of agreement, both presidential candidates have said that they want to exempt tip income from taxation. Both announced their plans in Las Vegas, which is not surprising because Nevada, a swing state, has the largest service industry in the country.
So, agreement in divisive times is promising, right? Well … maybe.
At least some economists aren’t keen on this proposal. In a recent op/ed published on the Brookings Institution website, William Gale and Ian Berlin of the Urban-Brookings Tax Policy Center wrote: “The obvious problem is that the proposals are inconsistent with sound tax policy.” They added, “If the candidates want to help low-wage workers, they should be direct in their approach. A ‘no taxes on tips’ approach will not do the trick, and the distortions in the tax system outweigh the few benefits it might provide.”
Moreover, partisan politics quickly took hold: taking cues from their respective candidate, Democratic and Republican legislators proposed competing bills with different rules.
Differing Proposals and the Federal Tip Credit
While both candidates propose eliminating the tax on tips, Vice President Kamala Harris’ position is both more nuanced and expansive. Reports indicate that her plan would prohibit high earners from claiming the tax exemption and limit the exemption to just the income tax and not Federal Insurance Contributions Act (FICA) withholding.
Additionally, she has called for the elimination of the “tip credit.” The tip credit allows companies in the hospitality industry to pay employees a lower “minimum cash wage” if their tip income puts them at or above the federal minimum wage, which is currently $7.25. By eliminating the credit, all employees would be guaranteed a minimum cash wage of at least $7.25, in addition to any gratuities they receive.
Rep. Steven Horsford (D-Nevada) recently introduced the TIPS Act, which attempts to codify much of this proposal. Of note, this bill not only abolishes the federal tip credit, but also limits the tax exemption to employees earning up to $112,500 in a calendar year.
Former President Donald Trump’s plan takes a simpler approach, with no earnings cap to qualify for the tax exemption and no stated proposal to eliminate the tip credit. Sen. Ted Cruz (R-Texas) introduced the No Tax on Tips bill in June, which echos this approach and simply permits all employees to claim a tax deduction equal to their cash tips.
Tipped Employee Classification
Incidentally, earlier this year, the 5th Circuit Court of Appeals struck down the so-called “80/20/30” rule related to how much time tipped employees can spend doing tasks that are not related to their tipped-producing duties, such as clearing tables for up to 30 minutes at a time, etc. Under the rule, if an employee crosses either the “20%” or “30-minute” threshold, an employer would no longer be eligible for the tip credit and need to compensate the employee at the full minimum wage.
It’s possible the U.S. Department of Labor could appeal the decision to the Supreme Court, though some analysts view this as unlikely and dependent on who wins the election. Of course, if the Harris proposal to eliminate the tip credit comes to fruition, then the standard becomes moot anyway.
Under a Trump administration, the rule would be unlikely to re-emerge for different reasons. Recently, the Republican-led House Subcommittee on Workforce Protections held a hearing titled, “Examining the Biden-Harris Attacks on Tipped Workers.”
During the hearing, Rep. Kevin Kiley (R-California), chairman of the subcommittee, described the rule as “essentially a requirement on small businesses to track their employees’ every movement minute by minute,” and “burdensome, invasive and altogether out of touch with the realities of working life.”
Republican members and their witnesses advocated for passage of the Tipped Employee Protection Act (H.R. 1612), which would prevent future regulators from splitting hairs over how to categorize the various tasks performed by tipped employees. This bill redefines what it means to be a tipped employee by ignoring employment duties and classifying employees as “tipped” if their combined gratuities and cash wage are equal to or greater than the minimum wage.
State Tip Credit Rules
Of course, the impact of any federal changes to the tip credit vary by state. Some states independently adopted a variation of the 80/20/30 rule. Others have an elevated minimum cash wage standard that is already comparable to or exceeds the overall federal minimum wage. Additionally, a small but growing number of jurisdictions have already eliminated the tip credit anyway. Chicago is in the process of phasing it out over the next five years, and Michigan will start a similar process in February 2025.
This November, voters in two states will decide on tip credit ballot measures that, if passed, would be unaffected by the Harris proposal. Specifically:
- Arizona’s Proposition 138 will ask voters whether the tip credit for employees who receive gratuities should be 25% of the state minimum wage. Currently, the tip credit in Arizona is $3 per hour. This would increase the tip credit to $3.58 and decrease the state’s current minimum cash wage from $11.35 to $10.77. However, an employer could only take the tip credit if the employee received at least $2 more than the minimum wage per hour in cash wages and gratuities combined. The current state minimum wage (excluding Flagstaff) is $14.35 per hour, adjusted annually for inflation. For an employer to take a tip credit, the employee would need to receive at least $16.35 per hour.
- Massachusetts Ballot Initiative No. 23-12 would, similar to Michigan, gradually increase the state’s minimum cash wage and decrease the state tip credit. If passed, the minimum cash wage would jump to $9.60 from $6.75 on Jan. 1, 2025, putting it at 64% of the state’s $15-an-hour minimum wage. Annual increases every year thereafter would eventually culminate in the complete elimination of the tip credit on Jan. 1, 2029. Interestingly, the initiative would also permit tip pooling, with all gratuities being divided among tipped and nontipped workers, once the entire workforce is compensated at or above the full state minimum.
Ready for a Hot Tip? PrismHR Has You Covered
While tipping might be the topic du jour this election cycle, PrismHR constantly monitors payroll-related regulatory changes so you and your clients can stay in compliance. Tipping included!
Our technology helps more than 100,000 businesses stay in compliance while removing the guesswork for HR outsourcers (HROs) through our solutions and decades of experience and expertise. Learn more about PrismHR.
Chris Babigian is PrismHR’s compliance strategy manager. A graduate of Boston University School of Law with a focus in taxation, Chris spent five years handling motions, appellate briefs and trial discovery for a civil litigation firm. In 2014, Chris transitioned to PrismHR, where he translates regulatory requirements into software solutions.