What to know about the 'no tax on tips' policy

Typically, the government wants a cut of any money you earn. But soon, tips earned on the job may become an exception to that rule.

Following promises from both parties during the last presidential election, the "no tax on tips" policy is now one step closer to becoming a reality after passing both the House and Senate. Should the bill become law, that would mean the end of federal income tax on tips — with some caveats.

How would the 'no tax on tips' policy work?

Put simply, the new bill would "make tip income exempt from federal income taxes," said The New York Times. Workers would still have to track and report tips, but instead of including them as income, "that amount will be subtracted from reported income as an 'above the line' deduction on a tax return." This would ultimately "reduce how much income tax is owed."

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The deduction would apply to "100% of qualifying tipped income, including tips that come from cash, debit and credit card transactions," said Money. It would be capped at $25,000 per year.

Who does 'no tax on tips' apply to?

This tax break would apply to those who "traditionally and customarily received tips on or before December 31, 2023," per the bill, which includes "waiters, bartenders and delivery drivers" as well as "beauty service workers," said Time. A complete list of eligible occupations is set to become available "90 days after the bill's passage."

Even in an eligible occupation, workers in order to qualify must "earn less than $160,000 in 2025" and have a Social Security number ("if they are married, their spouse must also have a Social Security number"), said CBS News. It is also necessary for the tips to be "reported to the employer and included on the worker's W-2 tax form."

Are there any drawbacks to the policy?

While the proposal has gotten widespread support in Washington and likely sounds appealing to those who get tips, it has not gone without criticism. For one, some detractors argue the bill would not do anything to help the lowest-earning workers. As it stands, "4 in 10 tipped workers earn too little to pay federal income taxes, which means they wouldn't see any benefit," said CBS News. Further, "other workers, like cooks, dishwashers or other behind-the-scenes staff who don't usually receive tips, won't receive a tax break under this bill," said Kiplinger.

There are also concerns that the new policy "would incentivize employers to keep base wages stagnant" as well as impact workers' "eligibility for other programs, such as the child tax credit and earned income tax credit, or reduce their contributions to Social Security," said Time.

When would the 'no tax on tips' policy take effect?

This policy is still not law. But if it is enacted, the change "would deliver immediate tax relief," becoming "available for tax years after Dec. 31, 2024, including the current tax year (2025)," said Money.