Donald Trump said it first, but Kamala Harris agreed; if either of them are elected president, they don’t want taxes on tips.
Can they do it? Is it a good idea? How would it affect small businesses and their employees? Since this hasn’t gone through legislation yet, this is an opinion piece coming from the perspective of an accounting and payroll professional.
At CSI Accounting & Payroll, we’ve worked with small business taxes for over 50 years. We’ve gotten a lot of questions about proposed law changes and how they might affect small businesses, including this hot topic from our current presidential candidates. Let’s discuss:
- Can Trump or Harris eliminate taxes on tips?
- In theory, what would this law change look like?
- Is eliminating taxes on tips a good thing?
Can the Candidates Eliminate Taxes on Tips?
For people who aren’t happy with how much we pay in taxes, less taxes sounds like a good thing.
That’s why it’s important to remember that both Trump and Harris want your vote and will try to appeal to you – which is why this topic was brought up in the first place. Whether or not they really think they can make it happen is another story.
It’s hard to foresee how a policy like this could be passed, especially with the growing tax gap in this country leaving tax-paying Americans to cover what’s leftover from those who don’t claim their tips.
Although we don’t think it will pass through legislation, we still want to infer what the policy may look like.
What Would Eliminating Taxes on Tips Look Like?
Neither candidate has elaborated much on what this would look like, aside from Harris saying she wants to avoid abuse of the potential policy by hedge fund managers and lawyers.
It’s unclear on who this policy would affect, and it’s unclear on which taxes would be removed.
Who Is Affected
Would it be for every tipped worker – or just direct tips? Some businesses have indirect tipping, or pooled tipping, that can be distributed in different ways. There are nuances to consider here.
Not to mention, employers pay taxes on employee tips, too! They can even currently claim the FICA tip tax credit for enforcing tip reporting. That credit may be affected if this law passes and removes FICA taxes from tips.
Another possibility would be that only employees have taxes removed from their tips, but their employer still needs to pay taxes on tips just like before.
Which Taxes Are Affected
Would it include every kind of tax that’s currently imposed on tips – or just income tax? Tips are currently subject to these taxes for both employees and employers:
- Social Security
- Medicare
- Federal income tax
- State and local income tax, if applicable
Employers also pay unemployment tax based on their employees’ total wages, which includes tips.
Unemployment tax, plus Social Security and Medicare (FICA) taxes help employees if they need to claim those government benefits in the future. Meanwhile, income taxes are used for the greater good – a variety of public goods and services.
The taxes that are removed from tips may include FICA taxes, income taxes, or both.
Is Eliminating Taxes on Tips a Good or Bad Thing?
What outcomes might we expect if any variation of this policy is passed?
Worker Motivation
Would eliminating taxes on tips motivate employees to work harder because they’d be taking home the entire tip, or would it allow them to work less for that same reason? Everyone has different motivations.
What about in other roles? For example, if a restaurant has tipped servers who are bringing home untaxed tip income, how would that be justified to the non-tipped chefs? A large pay gap would make it difficult to employ non-tipped positions.
Pay Shifts
As Harris suggested, a big concern is that businesses will try to shift more income from taxed regular pay to untaxed tips. The business would then pay less in taxes (if the law affects them), and so would the employees.
This could be a good thing (more money for the workers and/or business), but it can be a bad thing (amplifying negative consequences), which we will discuss in the remaining two points below.
Government Benefits
If FICA taxes are removed from tips, then the employee and employer (if not taxed) aren’t paying that portion of Social Security and Medicare for the employee to use. (Not to mention the growing concern that the Social Security Fund is becoming depleted because more benefits are being paid out than taxes are fortifying it!)
Worse yet, if the employer shifts the income to be mostly tips, even less funding goes to these benefits, plus unemployment.
Business owners can always opt to pay more or less into their FICA benefits, depending on their business entity. However, the average worker can’t elect to pay into these benefits, leaving them with lower Social Security and Medicare funds if this law passes.
Public Goods & Services
If federal, state, and local income taxes are removed from tips, then there’s no direct harm to the tipped worker and employer – but there is a shared societal consequence.
As mentioned above, there is already a huge tip gap in the U.S. that is left up to tax-paying people to address. There would also be less funding for public goods and services when we lose out on taxes that we’ve been counting on.
Stay Current With Small Business Tax Laws
All in all, due to a lack of details announced and a wide range of possibilities (many of which are negative), we don’t foresee the taxation of tips changing any time soon – even though both candidates are preaching it.
You don’t have to keep an eye on tax legislation when you own a small business – a monthly accountant and payroll specialist can do it for you all year round!
Are you ready to check out monthly accounting and payroll services? If so, please consider CSI Accounting & Payroll! To see if we can be a good fit for your business, click the button below for a free consultation:
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