Congress has delivered one of President Donald Trump’s hallmark campaign promises: a tax break for tipped workers. But the federal government’s next task, standing up the new law, may have unintended complications and consequences for workers and businesses.
The text of the law raises questions over whether the exempt income includes tips paid through online payment apps, which the IRS has historically included in tipped income, or only those paid in cash or credit. The same lack of clarity goes for what occupations are considered “tipped occupations” that are eligible for the tax break.
It’s also unclear how an IRS that will lose about a quarter of its workforce by the end of the year can implement the campaign promises in time for next year’s filing season. It will be up to the employee to claim the deduction at the end of the year, meaning the responsibility and liability of ensuring that records of their tips are accurate largely falls on them. And the legislation can be read as building in an incentive for employers to rely more on gratuities to pay wages.
Until the IRS puts out guidance on how to follow the law, those trying to comply are left guessing about what’s needed to show they qualify.
“The consequence of a lack of guidance or delays is confusion for honest taxpayers who are trying to comply and advantages for those trying to avoid paying to pay their taxes,” said Brandon DeBot, a senior attorney adviser and policy director at the New York University Tax Law Center.
Honors system
The tax break is meant for workers who traditionally receive tips, though they will still need to pay state and payroll taxes. The recently passed tax law limits that deduction to $25,000.
Roughly 4 million people—less than 3% of the American workforce—are in tipped jobs. But the break wouldn’t help all of them. The lowest-earning tipped workers won’t benefit much, or at all.
Under current law, employees are expected to report their tip earnings to their employer, and employers are required to maintain records of those tips and withhold appropriate income taxes.
There are many unanswered questions about what types of tips will qualify for the tax break, which could lead to confusion for filers come tax season, experts say.
“Who’s going to be eligible? What industries?” asked Julie Schweber, a senior HR compliance specialist with the Society for Human Resource Management of the questions employers are asking. “What about the plumber that you want to tip? Is that going to qualify?”
The Senate and House language defines eligible tip income as “any cash tip received by an individual in an occupation which customarily and regularly received tips.”
While that language is broad, it leaves out a major source of tip income: gratuity sent via payment apps like Cash App and Venmo.
“We want clarity whenever we have new legislation,” said Schweber. “The bill mentions a cash tip, but that’s kind of going by the wayside, with Venmo and PayPal and credit cards and all of that.”
Current IRS guidance defines cash tips as payments received from customers via debit or credit cards, tip pooling arrangements, or cash.
More Tips
Employers may be enticed to expand the share of positions that are eligible for tips, Schweber and other management-side attorneys said, if workers begin to seek out tip-earning positions due to the opportunity for the future tax break.
But management-side attorneys caution that there’s legal limitations to the types of workers who can participate in tip pools or receive tips.
Under the Fair Labor Standards Act, employers are allowed to pay tip-earning workers as little as $2.13 per hour so long as the worker earns at least $30 a month in tips and the employer ensures their tip earnings reach at least the minimum wage at the end of the workweek.
Workers can be treated as tip-earning employees so long as they are in an occupation “in which he customarily and regularly receives more than $30 a month in tips.”
Employers also can allow staff to enter into tip pooling arrangements where gratuities are split evenly among tip-earning staff. But if a tip pool includes any workers who don’t normally receive tips, the employer must pay all staff in the arrangement the full federal minimum wage of $7.25.
“I think we need to be careful about not trying to create something out of nothing if a position is not fundamentally one that involves the kinds of activities that ordinarily in the language of the statute, customarily and regularly receive tips,” said Paul DeCamp, a management-side attorney at Epstein Becker & Green. “Trying to make a tip position out of one that isn’t really within the wheelhouse for tips creates probably more problems than it solves.”
Making It Work
While lawmakers on both sides of the aisle voted for it and it was popular in polling, implementing a regime on no tax on tips won’t be as plain sailing.
The IRS will have to update forms and systems, and train its customer service workers on the new provisions as about 22% of its customer service workers and 27% of tech employees look to leave by the end of the year. On the back end, it’s still unclear what the agency’s audit priorities will be, another area that has seen significant cuts.
The exodus of people and knowledge, paired with expected funding cuts, will make it difficult to quickly implement the tips promises ahead of filing season, policy experts and former IRS leaders said.
“If there’s any significant tax law change—and I’m not talking just about extenders but certain types of income not being taxable—that is going to introduce a tremendous amount of challenge that people need to be thinking about in terms of systems that we need to update,” former acting IRS Commissioner Doug O’Donnell said earlier this year.
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