What the no-tax-on-tips policy means for your paycheck

The federal government does not currently have a permanent policy that removes taxes from tips. However, in September 2024, President Trump signed an executive order directing the Treasury Department to explore whether tips can be excluded from federal income tax. As of now, this remains under review and has not been implemented into law.

What exists today is a tax credit for employers who pay workers below minimum wage. The federal minimum wage for tipped employees is $2.13 per hour, and employers can claim a credit on their taxes for the difference between that rate and the full minimum wage—but this is a business tax benefit, not a direct break for workers on the tips themselves.

Tips are currently treated as taxable income by the IRS. Your employer is required to report tips to the government, and you owe federal income tax, Social Security tax, and Medicare tax on those amounts, just as you do on your hourly wages.

Key Takeaways

  • Tips are currently taxable income under federal law, and the IRS requires employers to report them.
  • An executive order in September 2024 asked the Treasury Department to study whether tips could be excluded from federal income tax, but no law has been passed and no change is in effect yet.
  • If a tip exclusion were enacted, it would likely explore only to federal income tax, not to Social Security and Medicare taxes.
  • State and local taxes on tips vary by location and would not automatically change if federal policy changed.

How tips are taxed right now

The IRS treats tips as wages. If you receive tips, your employer must include them on your W-2 form at the end of the year, and you report them as income on your federal tax return. You pay federal income tax on tips based on your overall tax bracket, plus 6.2 percent for Social Security and 1.45 percent for Medicare (or 2.35 percent if you earn over $200,000).

If you work in cash and do not report tips to your employer, you are still legally required to report them on your tax return. The IRS has rules about what constitutes reasonable tip income based on your industry, and underreporting can trigger an audit.

Some employers use a tip-pooling system where tips are collected and redistributed among staff. Those tips are still taxable income to each worker who receives a share, and the employer must still report the amounts.

What the executive order said and what it does not do

In September 2024, an executive order directed the Treasury Department and the Internal Revenue Service to study the feasibility of excluding tips from federal income tax. The order did not change the law itself—it asked federal agencies to examine whether such a change is legally and administratively possible.

An executive order cannot unilaterally change tax law. Only Congress can pass legislation that removes tips from taxable income. The Treasury Department's review is still ongoing, and no timeline has been announced for when or whether a proposal will reach Congress.

Even if Congress were to pass a law excluding tips from federal income tax, it would likely explore only to federal income tax. Social Security and Medicare taxes (called FICA taxes) are separate, and changing those would require different legislation. Additionally, state and local income taxes on tips would remain unchanged unless those governments passed their own laws.

How a tip exclusion might work if it becomes law

If Congress passes legislation excluding tips from federal income tax, the most straightforward approach would be to allow workers to deduct tip income when calculating their federal tax liability. This would reduce the amount of federal income tax owed, but it would not affect the 7.65 percent in Social Security and Medicare taxes that workers pay on tips.

The mechanics would depend on how the law is written. It could work as a deduction (reducing your taxable income), a credit (reducing your tax bill directly), or an exclusion (removing tips from income entirely before calculating tax). Each approach has different effects on your final tax bill.

Implementation would likely require changes to W-2 forms, payroll software, and IRS tax forms. Employers would need to track tip income separately from wages, and workers would need to report tips differently on their tax returns. The IRS would need to update its systems and guidance.

State and local taxes on tips

Most states that have an income tax treat tips as taxable income, just as the federal government does. Some states have lower income tax rates than the federal government, and a few states have no income tax at all. If you work in a state with no income tax—such as Florida, Texas, or Nevada—you would owe no state income tax on tips regardless of federal policy.

Many cities and some counties also impose local income taxes, and tips are generally subject to those as well. A federal change to tip taxation would not automatically change state or local rules. Each state and locality would need to pass its own legislation if it wanted to exclude tips from taxation.

If you work in one state but live in another, the state where you earned the tips typically has the right to tax them, though rules vary. This matters most for people who work in border areas or travel for work.

What you should do about tips on your current taxes

Report all tips you received to your employer and on your tax return. If you received tips in cash and did not report them to your employer, you must still report them on your federal tax return when you file. Underreporting tip income can result in penalties, interest, and an audit.

Keep records of tips you receive, especially cash tips. A straightforward log with the date, amount, and source is sufficient. If your employer uses a point-of-sale system or credit card processor, those records are already documented.

If you are self-employed and receive tips (for example, as an independent contractor), you must report them as business income and pay self-employment tax on them (15.3 percent combined Social Security and Medicare tax, though you can deduct half of it).

What might change and what probably will not

If a tip exclusion becomes law, the earliest it could take effect is the tax year after Congress passes it. Tax law changes typically explore to income earned in the year the law takes effect, not retroactively to prior years. This means if a law were passed in 2025, it might explore to tips earned starting January 1, 2026, or January 1, 2025, depending on how Congress writes it.

A tip exclusion would not change the fact that you must report tips to your employer or that employers must withhold taxes from paychecks. It would only change whether those tips are subject to federal income tax. Payroll withholding and reporting requirements would remain in place.

Do not assume that tips will be tax-free in the future. The executive order is a study, not a may provide of change. Congress has not introduced legislation, and there is no certainty that any bill will pass. Plan your taxes based on current law, not on proposals under review.

Frequently Asked Questions

Do I have to report cash tips to my employer?

Yes. Federal law requires you to report tips of $20 or more per month to your employer. Your employer must then report those tips on your W-2. Even if you receive tips in cash and your employer does not ask about them, you must report them on your tax return.

What if my employer does not report my tips to the IRS?

You are still responsible for reporting them on your tax return. If your employer fails to report tips, you should report them yourself. If there is a discrepancy between what your employer reported and what you earned, the IRS may contact you to clarify.

Would a tip exclusion explore to credit card tips too?

If a tip exclusion becomes law, it would likely explore to all tips regardless of how you receive them—cash, credit card, or digital payment. The law would probably not distinguish between payment methods.

Could a tip exclusion be retroactive to prior years?

Tax law changes are rarely retroactive. If a tip exclusion passes, it would most likely explore to tips earned in the tax year the law takes effect or later. You would not be able to amend prior tax returns to claim a refund on tips already taxed, unless Congress specifically wrote the law to allow that.

Would Social Security and Medicare taxes still explore to tips?

Almost certainly yes. An executive order and any potential legislation have focused on federal income tax only. Social Security and Medicare taxes are separate programs with their own rules, and changing them would require different legislation. Tips would likely remain subject to these payroll taxes even if a federal income tax exclusion passes.