Sen. Ted Cruz (R-TX) and Rep. Byron Donalds (R-FL) recently introduced the "No Tax on Tips Act," which proposes exempting tips from income taxes. This legislation could significantly influence tax policy in the coming year.
The enthusiasm among supporters of the 2017 Tax Cuts and Jobs Act for this new bill suggests a need for more pro-worker tax policies, as the 2017 law favored wealthy individuals over low- and middle-income families. Extending parts of the 2017 tax law would result in an average $500 tax cut for households in the bottom 60 percent, compared to a $280,000 cut for those in the top 0.1 percent.
However, critics argue that the No Tax on Tips Act is flawed because it excludes over 95 percent of low- and moderate-wage workers who do not work in tipped occupations. For many tipped workers, any potential tax cuts would be minimal or nonexistent. The American Rescue Plan's enhancements to the earned income tax credit (EITC) and child tax credit (CTC), which some propose making permanent, offer more substantial benefits to working families. For instance, a single parent earning $19,000 in tips and $5,000 in wages would receive no benefit from Sen. Cruz’s bill but would get a $1,090 tax cut from restoring the CTC expansion.
Additionally, there are concerns that high-income professionals could exploit this legislation by shifting their compensation to a tax-free tipping model. This could lead to significant tax breaks for these individuals compared to lower-income workers. For example, a married couple earning $1 million could potentially save $180,000 by reclassifying half of their wages as tips.
The No Tax on Tips Act provides an above-the-line deduction for tips from employees' income taxes while maintaining payroll taxes on tipped income. Despite appearing to address distributional flaws of the 2017 tax law by targeting low-wage workers in tipped professions like waiters and hairdressers, it fails to deliver meaningful pro-working-family reform.
Economist Ernie Tedeschi estimates that only 2.5 percent of U.S. workers are tipped employees, with less than 5 percent among those earning under $25 per hour receiving tips. Consequently, more than 95 percent of low- and moderate-wage workers would see no direct benefits from this bill.
Moreover, many tipped workers already pay no income taxes due to low earnings; thus, they gain nothing from this deduction. Even those who do pay some income taxes might see negligible reductions.
Parents might also miss out on benefits due to interactions with congressional Republicans’ changes to the CTC structure since families need income tax liability to receive the full credit.
A more effective approach is restoring expansions under the American Rescue Plan for EITC and CTC credits as proposed by President Biden's fiscal year 2025 budget and Sen. Sherrod Brown’s Working Families Tax Relief Act of 2023.
These expansions would increase CTC amounts per child and make them fully available to low-income families while nearly tripling EITC for childless low-wage workers without age restrictions.
Concerns remain that high-income professionals could game Sen. Cruz’s bill due to insufficient guardrails preventing recharacterization of wages or business profits as tips—potentially leading hedge fund managers or lawyers into significant untaxed windfalls compared with other avoidance schemes like carried interest loopholes or Gingrich-Edwards loophole strategies currently used by wealthy individuals.
