No Tax on Tips?

No Tax on Tips?

Many Americans have heard the Republicans going on and on about canceling all taxes on wages earned as tips. However, our tax system is not that simple. The taxes that Americans pay are split between Medicare, Social Security, Federal taxes, and State/Local taxes—all of these are reflected on the yearly W-2 that your employer gives to you.

Current Tax Impact on Tip-Earned Income

Now, to be honest, most Americans who work in the tip-earning industry currently pay very little in taxes annually. Most of the money that is taken out of your check goes to Medicare, Social Security, and State/Local taxes, with only a very small portion attributed to Federal taxes.

Presidential Power to Cancel Federal Tax on Tips

So you might ask, can a President cancel tax on tips? Technically, yes, by executive order, but only the Federal tax. For the sake of this blog, let’s imagine that Ex-President Trump said what the American people wanted him to say: “When you elect me President, I will make all tips unreportable income.” If that were to happen, then if you work in an industry that allows you to receive tips from customers, then you can keep all that money, no questions asked.

Unreportable Income Professions

Yes, some jobs earn unreportable income, such as Religious Clergy and Notary Public. However, keep in mind that individuals who work in these professions do not receive any type of federal aid for retirement, such as Social Security or Medicare.

Example of a Waitress’s Income

Let’s start with the way that most professions that receive tip income receive wages, like waitresses, since Trump says that is how he got the idea. That waitress probably receives a wage of $3.50 per hour plus tips. Now, if she does not have to report her tips, her employer will just withhold Federal, Social Security, Medicare, and State/Local taxes on $3.50. In addition, if she works 40 hours a week for 52 weeks, she will have a yearly income of $7,280.00 to report. Since she will be way below the poverty level, she will never be able to purchase a car or a home, and she will also be ineligible for a child tax credit or earned income credit on her tax return. This poor waitress will never be able to build a sustainable life, reporting an income this low. To make things worse, if she were 47 today and retired at 67 years old, she would receive a monthly income of $1,302.00 per month and be expected to pay Medicare premiums and healthcare costs out of that! She would never survive today’s groceries, rent, and utilities.

Employer Contributions and Savings

 Currently, employers are required to pay half of their employees' Social Security and Medicare taxes. That is your employer’s way of contributing to your retirement, and the Federal government makes sure they collect it for you. So, this will also save your employer money.

Impact of Unreportable Tips on Workers

However, when a waitress reports her actual tips along with her hourly wage, that will often come to at least $100.00 per day ($28 in hourly wages and $72 in customer tips). That equals out to $500 per week and $26,000 per year. That allows her Social Security income to go up to $1,821 per month plus healthcare, and now she is eligible to receive the child tax credit and earned income credit. She also would have a better chance of getting a car loan. So, the bottom line is that if tips become unreportable, it will make it much harder for workers in this industry to survive, and this will burden our system in ways we haven’t seen since the 1920s.

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