No Tax on Tips Act and the TIPS Act are poised to impact restaurant labor costs, payroll taxes, and compliance by excluding tips from taxable income.
Washington D.C. is showing alignment on excluding tips from taxable income, and definitive legislation is on the horizon. This has significant implications for restaurant operators as the specifics of the final legislation could increase labor costs, reduce payroll tax obligations, and create a number of other potential compliance violations.
The big question is what this will mean for your restaurant. Let’s explore the legislative landscape and consider the changes coming down the pike.
The conversation around excluding tips from taxable income began when President Donald Trump promised to deliver this policy on a campaign stop in Nevada, which was echoed by then-Vice President and presidential candidate Kamala Harris. Since then, Congress has put forward two bills to address the issue:
Both bills ultimately have the same goal and were written for similar pro-worker reasons. Congressman Horsford said, “A tip is a gift — it’s not a guarantee. It’s not something that service employees can bank on. And it’s not something that should be taxed.” Meanwhile, Ted Cruz defended his own bill by invoking the needs of tipped employees, “I’ve long believed the GOP should be the party of bartenders, of waiters and waitresses, and this bill is an important step to ensure we are addressing the economic needs of working Americans.”
Both bills are under consideration in Congress with bipartisan support. Congressman Horsford has even gone so far as to cosponsor the No Tax on Tips bill, saying the bill is another “opportunity for us to eliminate the income tax requirement for most tipped workers and ensure that bad actors can’t use it in inappropriate ways.”
This level of alignment across parties suggests that a version of one of these two bills has a good chance of being passed into law. However, the bills are not identical and have one major distinction between them. The TIPS Act would also remove the tip credit system and tipped minimum wage at the federal level in addition to excluding tips from taxable income. This could mean a serious increase to your labor costs and could result in a large raise for all employees making a tipped minimum wage, depending on what state your business operates in.
As it stands, the federal minimum wage is $7.25 with a tipped minimum wage of $2.13 and tip credit of up to $5.12. That means that a tipped employee can be paid a cash wage of $2.13 with the expectation that earned tips will equate to at least $5.12 per hour bringing their total compensation in line with the federal minimum wage.
If the tipped minimum wage were to be eliminated, that same employee must be paid at least $7.25 regardless of how much they earn in tips. Beyond that, earned tips would still be tax exempt.
It is important to note that this only modifies federal standards and requires employees to be paid the federal minimum wage. There are many states that still use a tip credit and tipped minimum wage system, but the wages are already above the federal levels. For example, the Arizona minimum wage is $14.70, but the tipped minimum wage is $11.70 with a $3.00 tip credit. Were the TIPS Act to pass, the minimum wage of Arizona employees would not be impacted.
However, if you operate in a state with tipped minimum wages in-line or close to the federal baseline, the TIPS Act could result in a significant uptick in labor costs. For example, the tipped minimum wage in Delaware is $2.23, still above the federal tipped minimum, but well below $7.25. These restaurant operators would be obligated to triple the employee’s wages to maintain compliance. Extrapolated across the entire team, and your restaurant’s labor costs could dramatically rise because of this legislation.
Operators in affected states should take steps now to evaluate their operating expenses and understand what impact this will have on the profitability of their business.
Though the TIPS Act could raise labor costs in restaurants in some states, it may also make the payroll process easier or more profitable for the business. If tips are no longer taxed, it could simplify tax reporting for employees. Under existing law, employers must maintain detailed records of received tips to ensure taxation is collected properly. The reporting requirements may be lessened if tax policies change.
Moreover, employers must currently make withholdings from tips for Social Security, Medicare, and federal income taxes, which requires complex payroll calculations. If tax were to no longer be collected, the withholdings process would become that much easier to calculate and report.
Operators must stay ahead of state and federal updates to ensure their processes align with any new regulations passed. This could require a reevaluation of tip pools, reporting processes, and employee compensation structures. The bills are public information and available for review, and ultimately only one of the bills, if any, will pass.
Read the Tipped Income Protection and Support Act here.
Read the No Tax on Tips Act here.
In the meantime, help ensure your organization is fully compliant with relevant labor laws with our Definitive Guide to Compliance for Restaurants. Download your copy today.
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