Taxation of Tip Income (CRS Report for Congress)
| Release Date |
Revised Oct. 28, 2024 |
| Report Number |
IF12728 |
| Report Type |
In Focus |
| Authors |
Brendan McDermott |
| Source Agency |
Congressional Research Service |
| Older Revisions |
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Summary:
Federal law generally requires workers to pay individual
income taxes and the payroll taxes on their tip income, as
on other compensation. Lawmakers have introduced several
bills in recent years to exclude tip income from the
individual income tax, and in some cases, from payroll
taxes. This In Focus explores the tax treatment of tips and
the potential consequences of excluding tip income from
taxation.
Tips are generally considered wages for payroll tax
purposes. Federal payroll taxes include taxes on both the
employee and employer of 6.2% of a worker’s wages up to
a taxable maximum ($168,600 in 2024) to finance the
Social Security trust funds, as well as of 1.45% of a
worker’s wages to finance the Medicare Hospital Insurance
trust fund; these taxes are commonly referred to as Federal
Insurance Contribution Act (FICA) taxes. Individuals also
pay an Additional Medicare Tax of 0.9% on compensation
exceeding $200,000 ($250,000 for couples married filing
jointly; $125,000 if married filing separately). The Tax
Policy Center estimates that roughly 67% of households
with incomes below $100,000 in 2023 paid or generated
more in payroll taxes than in individual income taxes,
including both the employer- and employee-side taxes.
Employers must pay the employer portion of payroll taxes
on tips that their employees receive. Food and beverage
businesses at which tipping is customary can receive a
credit against their income tax liability for FICA taxes paid
on tips exceeding the amount needed to meet a wage of
$5.15 per hour for each tipped employee.
Employers also pay a Federal Unemployment Tax Act
payroll tax. This tax is usually worth 0.6% (net of credits
for state unemployment taxes) on each employee’s first
$7,000 earned, including tips. Employers (and employees,
in some states) also pay state unemployment insurance
taxes, the rules for which differ by state.
