Social enterprises and nonprofits already operate in resource-constrained environments. When national policy choices erode the financial bedrock, like payroll taxes that fund Social Security, it affects the long-term sustainability of the entire ecosystem. The opportunity lies in holistic reform: raising the tipped wage, modernizing payroll systems, and protecting shared financial infrastructure. At Inter CPA, we believe that fiscal decisions must be judged not only by their short-term benefits, but also by their contribution to a resilient and equitable future.
The notion of eliminating taxes on tip income has gained buzz recently as a way to put more money in the pockets of restaurant servers and other tipped workers. It sounds appealing after all, who wouldn’t want hard-working waitstaff to keep more of their tips? Several politicians have floated versions of a “no tax on tips” plan, framing it as relief for working families. However, as CPA at Inter CPA, we see this well-intentioned idea as a mistake that could backfire. Removing the tax on tips might boost take-home pay in the short run, but it would create perverse incentives and undermine the very systems that protect workers in the long run. In other words, “no tax on tips” is a bad idea once you examine the broader consequences.
Tips Are a Business Subsidy, Not Just a Bonus
Tipping in the United States and Puerto Rico isn’t just a reward for good service; it’s baked into the pay structure of entire industries. Because federal law allows a “subminimum” hourly wage of just $2.13 for tipped workers, customer tips make up the rest of a worker’s basic income. This two-tiered wage system means customers’ gratuities effectively subsidize the employer’s wage bill . In fact, what was once a mere token of appreciation has become part of the business model: at the federal level, customers’ tips cover a $5.12 gap per hour (the difference between the $7.25 regular minimum wage and the $2.13 tipped wage) . That $5.12 is money the restaurant or bar isn’t paying its worker – the customer is. In this light, tips function as a form of employer subsidy provided by patrons, rather than purely extra salary earned on top of wages.
Why is this important for the tax debate? It highlights that tip income is not really “the icing on the cake”; it’s often the cake itself. Treating tips as a special, untaxed category suggests they’re an unrelated bonus, when in reality, they substitute for wages an employer would otherwise have to pay. Exempting such a large portion of service workers’ earnings from tax breaks the normal link between earnings and taxes, and it does so in a way that benefits businesses as much as workers. Before long, businesses could lean even more on customers to pay workers’ earnings tax-free, further shifting the burden of compensation onto consumers.
Loopholes and Shifting Compensation
Creating a tax-free zone for tips would also open the door to large loopholes and gamesmanship. Any time one type of income is taxed and another is not, people find ways to reclassify income to the untaxed category . If tip income gets a special exemption, it’s easy to imagine employers and employees finding “creative” ways to label more payments as tips. Could bonuses, service fees, or even portions of hourly pay quietly be converted into “tips” to dodge taxes? Although tax law defines a tip strictly (it must be voluntary and customer-determined), enforcement is a different matter. The IRS can’t monitor every transaction, and “a hole in the tax base like ‘no tax on tips’ is an invitation to tax evasion,” as one analyst warns. In short, a no-tips tax policy invites abuse. It would incentivize businesses to shift more of their compensation structure towards tips or pseudo-tips, knowing that money comes with a lighter tax burden. Workers might push for more of their pay to come as tips as well, since take-home pay would be higher, but that only amplifies other risks, like income instability and reliance on customer moods.
Beyond outright evasion, the policy could distort the labor market. Jobs that rely heavily on tips would become relatively more attractive (tax-wise) than jobs with traditional salaries. For example, a restaurant server earning mostly untaxed tips could net more than a similar-wage retail employee whose whole paycheck is taxed. Over time, this skew could draw more workers into already low-paid, tip-reliant sectors and put untipped fields at a hiring disadvantage. It’s an odd outcome: a tax tweak intended to help low-income service workers could end up cementing a tipping-dependent low-wage economy, with more workers chasing tip-based jobs instead of jobs with stable salaries.
Undermining Social Security Funding
Perhaps the most serious concern is what exempting tips from taxation means for Social Security. Under current law, both workers and employers pay Social Security payroll taxes on tip income, just as they do on regular wages. Those taxes flow into the Social Security trust fund, which is already facing long-term shortfalls. Carving out tips from Social Security taxes would siphon off a growing stream of contributions at the worst possible time. According to nonpartisan analysis, proposals like ending taxes on tips (and similar ideas like untaxed overtime pay) would widen Social Security’s funding gap by hundreds of billions of dollars . In fact, the Committee for a Responsible Federal Budget estimates that such plans could move up Social Security’s insolvency date by about three years, from 2034 to 2031 . That means the trust fund would run dry even sooner, forcing across-the-board benefit cuts or requiring a taxpayer bailout even earlier than anticipated.
This isn’t just an abstract fiscal problem; it directly affects workers’ futures. The same servers and bartenders enjoying a small tax break on tips today could see lower Social Security checks tomorrow. Social Security benefits are calculated based on lifetime taxable earnings. If tips aren’t taxed, they may not count toward a worker’s earnings record for benefits. In other words, a bartender in her 30s might take home a bit more cash now, only to receive a smaller Social Security check when she retires or face a system too depleted to pay full benefits. Raiding Social Security for revenue is a shortsighted trade-off. It undermines a safety net that millions of workers, including those in tipped employment, will rely on in their later years. With the program already slated to cut benefits by ~23% when the trust fund is exhausted, hastening that crisis by exempting a chunk of payroll from taxation is dangerously irresponsible. Simply put, you can’t protect workers by starving the very program that will support them in old age.
A Better Path Forward for Workers and Policy
If the goal is to help tipped workers and low-wage employees, there are smarter, more responsible alternatives than a blanket “no tax on tips” policy. One approach is to address the root issue: the subminimum tipped wage. Policymakers could gradually raise or eliminate the $2.13 tipped minimum wage so that employers, not customers, bear the primary responsibility for employee pay. This would reduce workers’ heavy reliance on tips to earn a living, while still allowing genuine tips to be a bonus for excellent service. Seven states have already moved to require one fair minimum wage for all workers (tipped or not) and have thriving restaurant industries. Ensuring workers earn a solid base wage is a direct way to support incomes without creating tax loopholes.
Another approach is targeted tax relief that does not undermine Social Security. Instead of exempting certain income from payroll taxes (and thus from Social Security funding), policymakers could use general revenues to boost workers’ take-home pay. For instance, an expanded Earned Income Tax Credit or a refundable tax credit for low-income service workers would put extra cash in their pockets, financed by the broader budget, not by cannibalizing Social Security contributions. This type of solution could be implemented to support workers struggling with inflation and low wages, while maintaining the Social Security trust fund’s solvency.
In short, the responsible path is one that protects workers and strengthens the systems on which they’ll depend. We don’t need to create new tax loopholes to help working families. We need a comprehensive policy that ensures fair wages and sustainable Social Security for future generations. Good tax policy should lift up workers without mortgaging their retirement security or incentivizing evasive pay practices.
It’s time for a thoughtful discussion on how to support service industry workers the right way. What do you think about the idea of removing taxes on tips? We invite you to share your thoughts and questions. Let’s work together on solutions that truly benefit workers in both the short and long term. If you have questions about how tax policies could impact your organization or personal finances, reach out to Inter CPA.
Social enterprises and nonprofits already operate in resource-constrained environments. When national policy choices erode the financial bedrock, like payroll taxes that fund Social Security, it affects the long-term sustainability of the entire ecosystem. The opportunity lies in holistic reform: raising the tipped wage, modernizing payroll systems, and protecting shared financial infrastructure. At Inter CPA, we believe that fiscal decisions must be judged not only by their short-term benefits, but also by their contribution to a resilient and equitable future.
References
Committee for a Responsible Federal Budget (2024, October 21). What Would the Trump Campaign Plans Mean for Social Security? https://www.crfb.org/blogs/what-would-trump-campaign-plans-mean-social-security
U.S. Department of Labor. (n.d.). Minimum Wages for Tipped Employees. https://www.dol.gov/agencies/whd/state/minimum-wage/tipped
Social Security Administration. (2024). The 2024 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds. https://www.ssa.gov/oact/TR/2024/index.htm
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