The House of Representatives continues work on a reconciliation bill that would enact significant tax provisions and spending cuts. The various legislative committees have completed work on the areas of the bill within their jurisdiction, including the Ways and Means Committee, which proposed language that would enact $3.8 trillion in tax cuts over the next ten years. Over the weekend, the House Budget Committee consolidated the legislation, and the House Bill is now before the Rules Committee, where a managers’ amendment may be considered before it heads to the House floor. This article is one of a series of articles discussing various proposals in the legislation that touch on tax withholding, reporting, and fringe benefits.
The House Bill includes legislative language that would implement President Trump’s campaign proposal to eliminate the taxation of tipped income, at least temporarily. The language would allow an above-the-line deduction for certain tips received by an individual in an occupation in which tips are ordinarily received. However, several requirements, including those relating to the nature of the tip, the characteristics of the individual receiving the tip, and the relevant industry, must be satisfied. The provision would be effective for tips received on or after January 1, 2025, and would sunset after 2028—leaving its extension to a future Congress during a presidential election year. In addition, the legislation would extend availability of the FICA tip tax credit under Section 45B of the Code, which currently applies to food and beverage establishments, to employers within the beauty service industry.
Under longstanding guidance, tips provided by a customer to an employee are includible in the employee’s gross income and subject to federal income taxation as well as federal employment taxes. All tips received by an individual are subject to federal income tax, including (1) cash tips received directly from customers, (2) tips paid by credit or debit card, and (3) tips received under a tip-splitting or tip-pooling arrangement. Noncash tips, i.e. tips provided in the form of property, are also generally subject to income taxation.
Federal employment taxes are imposed on certain wages paid to employees, and include Social Security and Medicare taxes imposed under the Federal Insurance Contributions Act (“FICA”). FICA taxes are imposed on covered wages, which includes tips. With respect to tips, wages for FICA tax purposes include cash and charge tips of $20 or more received by an employee in a calendar month. Section 6053 generally requires employees to report to their employers the amount of tips received via a written statement if the employee receives cash tips of $20 or more in any given month. The employer then withholds FICA taxes and income taxes with respect to the reported tips to the extent possible from the employee’s non-tip wages and includes tipped wages on the employee’s Form W-2 (Wage and Tax Statement) for the calendar year.
Qualified Tips. The House Bill would allow an individual to reduce the individual’s taxable income by an amount equal to the “qualified tips” that the individual receives during a taxable year that are included on Forms W-2, 1099-K (Payment Card and Third Party Network Transactions), 1099-NEC (Nonemployee Compensation), or 4137 (Social Security and Medicare Tax on Unreported Tip Income) (as applicable). A qualified tip is any tip received by an individual in an occupation which traditionally and customarily received tips on or before December 31, 2024, subject to four limitations.
First, the tip must be paid voluntarily, without negotiation, and with the amount determined by the payor. This is generally consistent with the definition of a tip under IRS guidance over the last sixty-plus years. For example, in in Revenue Ruling 59-252, the IRS stated that to constitute a tip, the amount must be presented by the customer “free from compulsion,” the customer “must have the unrestricted right to determine the amount thereof,” and “such amount should not be subject to negotiation or dictated by employer policy.” The IRS has reiterated this guidance more recently in Revenue Ruling 2012-18.
Second, the proposal denies availability of the deduction for tips received by individuals providing services in certain industries, including health, law, accounting, certain investment services, and several others. These are the same occupations that are treated as a “specified service trade or business” for purposes of the Section 199A qualified business income deduction.
Third, the individual must not receive compensation from any employer in excess of the inflation-adjusted threshold under section 414(q) for highly compensated employees for the year, and such individual must not receive earned income in excess of that dollar amount. For the year 2025, the monetary threshold is $160,000.
Fourth, any additional requirements established by the Department of Treasury (“Treasury”) must be satisfied. Congress has authorized Treasury to promulgate a list of occupations in which tips are traditionally and customarily received.
Moreover, the deduction may be claimed only if the taxpayer provides its social security number on its tax return. If the taxpayer is married, the return must also include the taxpayer’s spouse’s social security number. This requirement will make those without work authorization in the United States ineligible for the deduction. The House Bill specifies that, for taxpayers who do not claim itemized deductions, the tip deduction is allowed in addition to the standard deduction.
Deduction Cannot Result in a Loss. Qualified tips may only be deducted to the extent that the gross receipts of the taxpayer from the trade or business (including any qualified tips) in which the tips are received for such taxable year exceeds the sum of (1) the cost of goods sold allocable to such receipts and (2) other expenses, losses or deductions (excluding the tip deduction) which are properly allocable to such receipts.
Information Reporting Changes. As described above, tip deductions to employees are only allowed for qualified tips reported by the employer on Form W-2. The House Bill would amend section 6051 to add a requirement to report the total tips reported by an employee to the employer on the Form W-2.
Similar to the rules for employees, the tip deduction is available to independent contractors and gig workers only with respect to tips reported to them on tax information returns. This may include Forms 1099-NEC and 1099-K. As a result, the House Bill would amend sections 6041, 6041A, and 6050W to add new reporting on Forms 1099-NEC and 1099-K to require the separate reporting of the amount properly designated as tips paid to an individual in an occupation eligible for the tip deduction. This may make many independent contractors who receive tips directly from non-business customers ineligible for the tip credit because such customers are not required to issue information returns reporting the tips to the contractors.
Withholding. In addition, the House Bill would instruct Treasury to adjust withholding tables to reflect the new deduction. It is unclear how that would be implemented, but it is possible that employers could be instructed to ignore any reported tips in calculating the amount of withholding provided the employee is expected to be eligible for the deduction.