Former President Donald Trump recently proposed a policy that could potentially change the landscape of the American service industry. During a rally, Trump floated the idea of making income from tips tax-free. This proposal, while seemingly beneficial to service workers, has raised concerns among tax-law experts who believe it could open the door to tax evasion and create a two-tiered labor market. (source)
Under a tax-free-tip system, employees who work for tips, such as waiters, bartenders, drivers, and some hotel staff, would have a financial advantage over other low-wage workers. They could avoid taxes for Social Security, Medicare, and income. However, this could also mean consumers would be asked to tip in additional situations so workers could receive untaxed income.
Martha Gimbel, the executive director of Yale University’s Budget Lab, warned that such a system would create an incentive for employers to try to get more of their workers’ compensation in the form of tips. This could allow business owners in industries such as hospitality to shift the responsibility for workers’ salaries onto consumers and claim tax breaks for themselves in the form of lower fees on payroll and Social Security.
Steven Bank, a tax-law expert and professor of business law at the UCLA School of Law, echoed Gimbel’s concerns. He suggested that the tax savings workers would get could be captured by the employer who’s lowered their pay. David Kamin, a tax-law and -policy expert at New York University and a former economic-policy advisor to the Biden and Obama administrations, argued that if the goal is to offer a tax break to low-wage workers, this proposal is not the way to do it.
Instead of creating a massive tax loophole, Kamin suggested that a more effective approach would be to give workers a tax cut that’s available irrespective of whether they’re making a wage or a tip. This would encourage workers to abide by the law rather than evade it.
As a tax attorney, I share these concerns. While the idea of tax-free tips may initially seem appealing, it’s crucial to consider the potential implications and unintended consequences. This proposal could potentially create a system that encourages tax evasion and places an unfair burden on consumers. It’s essential to promote responsible financial citizenship and ensure that our tax laws are fair, equitable, and not open to exploitation.