I bartend for a catering company as well as sell items online on Facebook Marketplace just to get by. Things are only now starting to get back to the way that they were pre-COVID, though tips still don’t really cut it. The new government said that they planned to eliminate tipping taxes, though my tip jar hasn’t seen any changes yet.

For millions of us in the service industry, tips are a crucial part of our income. Whether you’re a restaurant server, bartender, hair stylist, or delivery driver, customer gratuities help pay the bills. What many people don’t realize, though, is that the government takes a cut of those tips, too.

While employees are required to receive at least the minimum wage from their employers, tips traditionally make up for puny base pay. However, while cash presents or unorthodox barter are tax-exempt income, tips are not. That is, they must be reported by employees and taxed by employers accordingly. So just how much income does this add to government treasuries? And what is its effect on workers and the economy at large?

Tips are regarded as regular wages according to American taxation law. Tips must be accounted for by the employees to employers, and then payroll taxes such as Medicare and Social Security must be withheld from them. Workers who earn over $20 a month in tips are required to report income, according to the IRS. The employers are also required to cover some payroll tax on tips on behalf of workers, covering Medicare and Social Security.

Because many tipped workers earn a low base wage—the federal minimum for tipped employees is $2.13 an hour (although most states require higher)—tips often make up much of their overall income.

Tipping is extremely profitable for the government. It’s hard to estimate, but reports place billions of dollars in taxes collected annually from tip earnings.

According to IRS data, tips reported by employees are an important source of payroll tax revenue. Consider the following:

In 2018, restaurant workers alone reported nearly $30 billion in tips.

Payroll taxes (Social Security and Medicare) on the tips accounted for approximately $9 billion of tax revenue.

Add federal and state income taxes, and government collections of tips are even higher.

In spite of these numbers, the IRS estimates that much of the tip income is not reported. Estimates are that as much as 40% of tips are not properly reported, and tens of billions of tax dollars are lost.

The federal government depends on several sources of taxes to finance Social Security, Medicare, and other programs. Tax from tips contributes a small but significant amount to this system.

With the national debt now more than $34 trillion as of 2024, every tax dollar matters. While tip taxation is not a huge contributor to total federal revenue, it adds billions to government programs benefiting millions of Americans.

In times of economic recessions, tip tax revenue can decline drastically. When fewer individuals eat out, take vacations, or patronize service-oriented businesses, tip income declines—resulting in reduced tax collections. This can impose additional burdens on state and federal treasuries that are dependent on steady payroll tax revenues.

The taxing of tips has been a point of contention for decades. One argument is that taxing tips unfairly penalizes employees who already earn low wages. The other argument is that since tips are really income, they should be taxed as wages.

Arguments Against Taxing Tips:

Tips are voluntary payments by customers, as opposed to wages set by an employer.

Most tipped workers are already in economic distress.

The government loses billions of dollars in unreported tip income anyway, so enforcement is not effective.

Arguments In Favor Of Taxing Tips:

Tips are a form of compensation and should be treated in the same manner as all other income.

Payroll taxes on tips go to fund essential social programs.

Allowing tips to go untaxed would create an unfair advantage for certain industries.

Government taxation of tips is a huge but often overlooked source of funding. As tipping culture supports millions of workers, taxes on their income contribute billions to government programs. The dilemma is how to reconcile fair taxation with the capability of tipped workers to prosper.

For workers, being aware of tip reporting requirements is essential to prevent tax penalties. For the government, the enforcement of tip taxation is a continuing problem, with billions potentially lost to unreported income. With ongoing debate on wages, budget deficits, and tax equity, the place of tip taxation will continue to be an important question in fiscal policy.