The No Tax on Tips Act: Implications for Estate and Tax Planning

By: Randall A. Denha, J.D., LL.M.

Tipping has long been an integral part of the American service industry, providing employees with supplemental income that, like most earnings, is subject to taxation. However, recent legislative efforts—including the proposed No Tax on Tips Act (“Act”)—seek to exempt tip income from federal income tax. Similar proposals at the state level, such as in Wisconsin, have also gained traction. While this initiative may seem beneficial to tipped workers at first glance, its broader implications raise important concerns regarding long-term economic effects, administrative complexity, and estate planning considerations.

Potential Complications and Tax Compliance Challenges

From an estate and tax planning perspective, the Act presents multiple challenges, particularly in the areas of payroll taxation, income reporting, and business compliance. While the proposal seeks to exclude tips from income tax liability, it does not exempt them from payroll taxes. This distinction creates the potential for discrepancies in wage reporting, as employees may have an incentive to classify more of their earnings as tips, while employers must ensure accurate payroll tax compliance.

Additionally, business owners—especially those operating family-owned restaurants or hospitality enterprises—would face increased record-keeping burdens. Employers must ensure that deductions for wages align with the income their employees report, including maintaining separate records for tips versus regular wages, making tax filings more complex and potentially increasing liability risks. Further, questions remain as to whether this shift in tax treatment would alter compensation structures, potentially shifting the responsibility for paying fair wages from employers to customers.

Administrative Hurdles for Individuals and Businesses

If enacted, the Act would introduce additional compliance obligations for employees who rely on tip income. Currently, the IRS mandates that employees maintain a daily log of tips, report them to their employers, and include them on their individual tax returns. To claim the new tax exemption, workers would need to maintain more precise records to substantiate their claims. In addition, they may need to file IRS Form 4137 to report Social Security and Medicare taxes on any unreported tip income.

For estate planning professionals advising business owners and high-net-worth individuals, these reporting changes necessitate a proactive approach. Business owners will need to update their payroll systems, while individuals who receive tip income may require additional guidance on how to properly document their earnings to remain compliant with tax laws.

Concerns About the Act’s Economic Viability

Beyond administrative complexities, opposition to the Act highlights two primary concerns: its limited impact on tipped workers and the potential loss of federal tax revenue. Many tipped workers already have minimal or no federal income tax liability due to existing deductions and credits. As a result, the Act may provide little tangible benefit to the majority of these employees.

More significantly, according to Congressional Budget Office estimates, eliminating income tax on tips could result in a revenue loss exceeding $100 billion over a decade. Given that a portion of tip income is currently reported and taxed, the government would need to compensate for this shortfall, likely leading to increased taxes on other sources of income. Estate planning attorneys should closely monitor these developments, as they could influence tax rates and overall wealth transfer strategies.

How Taxpayers Can Prepare

With uncertainty surrounding the Act’s future, individuals and business owners who may be affected should consider the following steps:

• Strengthen Record-Keeping Practices – Employees who rely on tip income should begin tracking their earnings more diligently to ensure compliance with any new reporting requirements.
• Clarify Reporting Procedures – Employers and employees should align their reporting practices to maintain accuracy and avoid discrepancies in payroll filings.
• Monitor Financial Statements – Business owners must maintain up-to-date financial records to ensure compliance with payroll tax obligations and potential new tax laws.
• Seek Professional Guidance – Consulting with qualified tax counsel, estate planning attorneys, and certified public accountants can help individuals and businesses navigate the complexities of the Act, ensuring they remain compliant while optimizing their tax strategies and minimizing potential liability exposure.

Final Thoughts While the No Tax on Tips Act aims to provide relief to service industry workers, its broader implications create legal and financial considerations that cannot be ignored. Estate planning attorneys should be prepared to advise clients—both individuals and business owners—on the potential impact of this legislation, ensuring they remain informed and positioned for any changes in the tax landscape.