Do Servers Currently Pay Taxes on Tips? Why the New Proposal Matters

The short answer: yes, servers pay taxes on all tips they receive today. But a controversial new initiative could change that entirely—and it’s more complicated than just giving service workers a break. While servers struggling to pay taxes on modest tips might celebrate, critics warn that this “No Tax on Tips” plan could backfire and hurt the very workers it’s designed to help.

Understanding How Tips Are Taxed Today

Right now, the IRS treats tips like any other income. Whether a server receives cash tips, credit card payments, or digital transfers, every single dollar must be reported as taxable income. The cumulative effect is significant: service workers who already earn minimum wage—or in some states, just $2.13 per hour—now face federal, state, and payroll tax obligations on their gratuities.

This creates a real financial burden for millions of Americans. A server working a busy Friday night might pocket $150 in cash tips, but come tax season, that money becomes part of their reportable income, triggering tax liability. For workers earning modest incomes, this can push them into tax brackets or reduce credits they’d otherwise receive.

The No Tax on Tips Act: What’s Actually Changing?

The proposed legislation, endorsed by both President Donald Trump and former Vice President Kamala Harris, would make tips up to $25,000 per year exempt from federal income tax. The plan targets tipped workers in service industries—primarily restaurants and bars, but also expanding to beauty services like salons and spas.

Here’s the catch: under the original proposal, only cash tips that workers formally report to their employers for payroll purposes would qualify. More significantly, the exemption applies only to federal income tax. State income taxes and payroll taxes would not be affected unless individual states pass their own legislation. Additionally, workers earning over $160,000 annually would be excluded from the benefit.

The legislation also introduces a new tax credit for employers who process tips through beauty service establishments, expanding beyond traditional food and beverage settings.

Who Benefits and Who Might Actually Lose Out

At first glance, this policy appears straightforward: servers keep more of their tips. The Economic Policy Institute and other advocates frame it as a “lifeline” for workers struggling to make ends meet on minimum wage.

But the data tells a more nuanced story. According to research cited by the Economic Policy Institute, approximately 37% of tipped workers don’t earn enough to pay federal income tax in the first place. For these workers, the tax exemption might sound irrelevant—until you consider they could lose eligibility for crucial tax credits like the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC). These credits often provide thousands of dollars in annual relief to low-income families.

The deeper concern: employers might use this policy as cover to avoid raising base wages. Across America, the federal tipped minimum wage remains frozen at $2.13 per hour—unchanged since 1993. Many states have increased their own minimums, but others still permit wages far below living standards. With tips now tax-exempt, what incentive do employers have to raise base pay?

The Customer Impact: Why Tipping Culture Is Shifting

While servers and employers dominate the conversation, customers will feel the effects too. Service industries already face “tip fatigue”—the phenomenon where ubiquitous point-of-sale prompts asking for 18-20% tips have become socially awkward and financially exhausting.

This policy could accelerate that trend. As more industries adopt employer-driven tipping prompts, consumers may encounter tip requests in unexpected places: coffee shops, fast-food chains, and quick-service retailers increasingly expect voluntary gratuities at checkout.

The results are already visible. According to restaurant technology platform Popmenu, 38% of consumers reported tipping restaurant servers 20% or more in 2024—a dramatic decline from 56% in 2021. Meanwhile, Americans visited restaurants less frequently in 2024 than in 2023, suggesting that rising costs combined with tipping pressure may be reshaping consumer behavior.

The Bottom Line

Do servers currently pay taxes on tips? Absolutely. The new proposal would change that for federal income tax purposes, creating genuine relief for some service workers. But the full picture remains contested: Will it truly help low-income servers, or will it entrench wage stagnation while accelerating the tip-everywhere culture that frustrates consumers? The answer likely depends on how aggressively states and individual employers adapt to this shift.