Exempting Tips From Federal Income Tax Would Benefit Very Few Workers

Only a handful of all employees and fewer than 60 percent of tipped workers would benefit from proposals to exempt gratuities from federal income tax, according to a new Tax Policy Center analysis. Both Donald Trump and Kamala Harris have pitched versions of the idea in their 2024 presidential campaigns.

TPC estimates that only 2 percent of households would receive a tax cut if gratuities were free from federal income tax. If only those households with adjusted gross income of $75,000 or less were eligible, about 1.5 percent would benefit.

Around 3.3 percent of households would receive more take-home pay if tips were exempt from both income and payroll tax, and if there were no limit on eligibility.

Of course, there would be a major trade-off. By avoiding payroll taxes, these workers would not contribute to Social Security and Medicare. As a result, when they reach old age, they’d receive lower, or even no, benefits from those programs.

Limited Benefits

TPC figures exempting tips from income tax would reduce federal revenue by $6.5 billion in 2025, while capping the benefit to those making $75,000 or less would limit the revenue loss to $3.2 billion. Exempting both income and payroll tax for all tips would boost the 2025 cost to $13.5 billion.

Even among tipped workers, benefits would be limited. TPC estimated only about 60 percent of households with tipped workers would benefit if they could deduct tips from taxable income. Their average tax cut: about $1,800.

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If the tax break is limited to those making $75,000 or less, only about 46 percent of households with tipped workers would benefit, with an average tax cut of about $1,150.

Effectively, all workers who report tipped income would benefit if their gratuities also were exempt from payroll as well as income taxes. Their taxes would fall by an average of about $2,100 in 2025.

Stylized Examples

Since neither candidate has specified details of their ideas, TPC modeled stylized versions of a tip tax deduction. For example, it analyzed an income tax deduction for tipped workers making $75,000 or less, which appears to resemble Harris’s idea. And it estimated an exemption from both income and payroll taxes for all tipped workers, which may mimic Trump’s plan. Trump has not said whether payroll taxes would be exempt from his plan, though he has implied it would apply to all federal taxes.

The lowest income tipped workers would receive little or no benefit from the versions TPC modeled, primarily because most of them have so few earnings that they already pay no income tax.

For example, about 1.4 percent of households making $32,800 or less would get an income tax cut from a deduction for tipped income, averaging about $450. Among all households in that lowest income group, their after-tax income would increase by an average of about $10.

Who Benefits?

Exempting payroll taxes as well would boost the after-tax income of tipped workers by an average of about $700, though the lowest-income households, the vast majority of whom earn no tipped income, would get an average tax cut of only about $40.

Among tipped workers, the biggest beneficiaries would be middle-income households making between about $63,000 and $113,000. Their after-tax income would rise by an average of about 2.8 percent if they could deduct their tips from taxable income.

TPC’s analysis looked only at employees whose tips are reported on Form W-2s. It did not attempt to show the effects on independent contractors such as ride share drivers or some hairstylists, or on teenagers who are claimed as dependents on their parents’ tax returns. Nor did it show what would happen if workers shift from wages to tips in an effort to benefit from the tax exemption.

While Harris’s and Trump’s campaign ideas have received a great deal of attention, they would be irrelevant to more than 95 percent of households and even to many tipped workers.