Taxing Tips, The Debate

Removing income tax on servers' tip/gratuity income has been a topic of debate recently. Both Presidential candidates have touted potential policy changes. I did a little digging and have provided a brief breakdown of some of the Pros and Cons I found.

PROS:

1. Increased Take-Home Pay for Servers:
One of the most obvious benefits of removing income tax on servers' tips/gratuities is that it would directly increase their take-home pay. Many servers, bartenders, and other tipped employees rely heavily on gratuities to supplement their low hourly wages. Removing the tax on this income would provide a financial boost.

2. Boost to the Service Industry:
With a tax exemption on tip/gratuity income, servers may feel more incentivized to stay in or join the industry, potentially reducing high turnover rates. The industry, which often struggles with job retention, might see improvements in employee satisfaction and longevity. As a result, businesses may benefit from more experienced and motivated staff.

3. Easing Administrative Burdens:
For employers, tracking and reporting employees’ tip/gratuity income can be a time-consuming and complex task. Exempting tip income from taxation could simplify this process, reducing administrative costs and the chances of errors or compliance issues for both employers and employees.

4. Recognition of Unstable Income:
Server tips fluctuate based on several factors, including customer volume, seasonality, and economic conditions. By exempting tip income from taxation, the government would acknowledge the instability and unpredictability of this income source, providing relief to workers whose earnings are not guaranteed.

CONS:

1. Unequal Treatment of Income:
Critics argue that removing taxes on tip/gratuity income creates an unequal tax policy. Other workers who also earn variable or supplemental income, such as commission-based salespeople, still have to pay taxes on their earnings. This exemption could be unfair.

2. Potential for Underreporting & Fraud:
While tips are already difficult to monitor accurately, removing the tax could exacerbate the issue of underreporting. Servers may be incentivized to hide their earnings, particularly cash tips since they would no longer be obligated to pay taxes on them. This could create broader issues with tax compliance and transparency within the industry.

3. Inaccurate Data for Benefits and Obligations:
If tips are no longer taxed, servers might underreport their actual earnings to avoid income-based calculations for benefits like healthcare or child support obligations. This could distort economic data and cause other unintended financial discrepancies.

Conclusion

The removal of income tax on tips/gratuities presents a clear financial benefit to hospitality workers. However, this policy could lead to potential underreporting and concerns about fairness in tax burdens. 

The key challenge in this debate, I think, is balancing the need for tax equity with the desire to support hospitality workers.

Click Here to check out the article as it appeared in The Journal.