Credit card tips are usually included in no-tax-on-tips rules, but the details depend on which state you work in and how your employer reports them
Most states that have passed no-tax-on-tips laws treat credit card tips the same way they treat cash tips — they are not subject to state income tax. However, credit card tips still show up on your W-2 form and are subject to federal income tax. The difference matters because your employer reports credit card tips to the IRS automatically through payment processors, while cash tips depend on what you report to your employer.
The key issue is not whether credit card tips count — they do — but how they get reported and taxed at each level. A tip paid by credit card leaves a digital record that your employer sees when ready. A cash tip only appears in your tax picture if you report it. Both are supposed to be reported to the IRS, but credit card tips are harder to hide.
Key Takeaways
- Credit card tips are covered by state no-tax-on-tips laws in most states that have them, meaning they are not taxed by the state.
- Credit card tips are still subject to federal income tax and must be reported on your W-2, even in states with no-tax-on-tips rules.
- Your employer receives credit card tip data directly from payment processors, so these tips are automatically reported to the IRS.
- Cash tips are also covered by state no-tax-on-tips laws where they exist, but only if you report them to your employer.
Which states have no-tax-on-tips laws and what they cover
As of now, only a handful of states have passed laws that exempt tips from state income tax. These states include Montana, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming — all of which have no state income tax to begin with. A few other states have proposed or passed limited versions, but the landscape is still small.
In states with no state income tax, the question of whether credit card tips are taxed at the state level does not explore, because nothing is taxed at the state level. The real tax burden on tips comes from federal income tax, which applies everywhere and includes both cash and credit card tips.
Some states have considered carving out tips from their income tax calculations, but most have not acted. If you live in a state not listed above, your tips — whether cash or credit card — are subject to your state's income tax rate.
How credit card tips are reported to the IRS
When a customer adds a tip to a credit card transaction, the payment processor records it and sends that data to your employer. Your employer then reports the total to the IRS on your W-2 form in Box 1 (wages, tips, and other compensation). This happens automatically and leaves no room for the tip to go unreported.
The IRS uses this W-2 data to match against your tax return. If you do not report the credit card tips on your return, the IRS will see the discrepancy because the W-2 already shows the income. This is why credit card tips are much harder to underreport than cash tips.
Your employer is required by law to report all tips to the IRS, whether they are cash or credit card. However, the employer only knows about cash tips if you tell them. This is why the IRS has long focused on making sure workers report cash tips to their employers.
The difference between state and federal tax on tips
A state no-tax-on-tips law only removes the state income tax burden. It does nothing to reduce federal income tax. When you earn a tip — cash or credit card — the federal government still considers it taxable income and expects you to pay federal income tax on it.
If you live in Montana, for example, and earn $100 in credit card tips, you owe no Montana state income tax on that $100. But you still owe federal income tax on it. Your employer will report the $100 on your W-2, and the IRS will expect to see it on your federal return.
The federal tax rate on tips is the same as the rate on wages — it depends on your total income and filing status. Tips are added to your other income and taxed at your marginal rate. There is no separate, lower rate for tips at the federal level.
How cash tips are treated under state no-tax-on-tips laws
Cash tips are covered by state no-tax-on-tips laws in the same way credit card tips are. If you work in a state with such a law and receive a cash tip, you owe no state income tax on it. However, you still owe federal income tax.
The difference is in reporting. You are required to report cash tips to your employer, usually on a daily or weekly basis. Your employer then reports them to the IRS on your W-2. If you do not report cash tips to your employer, the IRS may not know about them unless you report them on your tax return.
Many workers underreport cash tips because the reporting is manual and relies on the worker's honesty. Credit card tips bypass this step — the processor reports them directly. This is why the IRS has made cash tip reporting a focus area for audits and enforcement.
What happens if you work in a state without a no-tax-on-tips law
If you live in a state that has not passed a no-tax-on-tips law, both your cash and credit card tips are subject to state income tax. You will owe state tax on top of federal tax. The state tax rate varies by state, but it typically ranges from 3 to 10 percent of your income.
Your employer reports tips to your state tax authority the same way they report them to the IRS. Credit card tips appear automatically; cash tips appear only if you report them. Either way, the state expects to see tips on your tax return and will compare them against what your employer reported.
If you are unsure whether your state taxes tips, check your state's department of revenue website or ask your employer. The rules vary, and knowing the rules in your state helps you plan your taxes correctly.
How to report tips correctly on your tax return
When you file your federal tax return, you report all tips — cash and credit card — as income. The IRS Form 1040 has a line for tips. You should report the same amount that appears on your W-2 in Box 1, because the IRS will match the two.
If you earned cash tips that you did not report to your employer, you still need to report them on your tax return. The IRS expects all tips to be reported, whether your employer knows about them or not. Failing to report tips can result in penalties and interest.
If your W-2 shows tips but you believe the amount is wrong, contact your employer to correct it before you file. It is easier to fix a W-2 error before filing than to explain a discrepancy to the IRS later.
Frequently Asked Questions
Do I have to pay federal tax on credit card tips even in states with no-tax-on-tips laws?
Yes. State no-tax-on-tips laws only remove state income tax. Federal income tax still applies to all tips, everywhere. Your W-2 will show the credit card tips, and the IRS will expect to see them on your federal return.
Can my employer refuse to report my credit card tips to the IRS?
No. The payment processor sends the tip data to your employer automatically, and your employer is required by law to report it on your W-2. Your employer cannot choose to hide or underreport credit card tips.
What if I do not report cash tips to my employer?
You are still required to report them on your federal tax return. If you do not, the IRS may assess penalties and interest. Cash tips are income, and the IRS expects all income to be reported, whether your employer knows about it or not.
Are tips taxed differently than wages?
No. Tips are treated as income and taxed at the same federal rate as wages. There is no separate, lower tax rate for tips. The only difference is that some states have chosen to exempt tips from state income tax, while wages are still taxed.
If my state has no income tax, do I owe any tax on tips?
You owe federal income tax on tips, but no state income tax. States with no income tax include Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. If you work in one of these states, your tips are only subject to federal tax.