Tipping culture has evolved significantly in recent years, particularly with the increasing use of digital payment kiosks and self-checkout lanes. Traditionally, tipping was reserved for service industries like restaurants, where it supplemented the lower base wages of employees. However, tipping has now extended to situations like ordering a to-go coffee or takeout, raising questions about how much to tip and the potential tax implications.
The Changing Landscape of Tipping
The COVID-19 pandemic played a significant role in reshaping tipping habits. Initially, many people tipped more generously to support service workers during uncertain times. However, as inflation continues to strain finances, many Americans are re-evaluating their tipping practices. A recent PYMNTS and LendingClub report revealed that nearly two-thirds of Americans are living paycheck to paycheck, making tipping decisions more complex.
This shift prompts an important question: How much should you tip, and what are the tax implications?
Understanding Tipping Standards
To better understand tipping standards, it’s essential to consider how different workers are compensated. Dr. Jaime Peters, assistant dean and professor of finance at Maryville University, explains, “It helps to understand how people are paid.” For instance, waitstaff at restaurants typically earn lower base wages, with tips expected to bring their earnings to or above the minimum wage. In contrast, roles like grocery store cashiers usually have higher hourly wages, and tipping is less common.
As tipping expands to include new scenarios, such as digital kiosks, determining when and how much to tip becomes more nuanced. Vincent Birardi, CFP and wealth advisor at Halbert Hargrove, advises that customers shouldn’t feel pressured to tip at automated kiosks. He suggests that if you receive exceptional service, a modest tip of $1 or $2 is appropriate, rather than the traditional 20%.
Who Deserves a Tip?
Traditional tipped roles include waitstaff, taxi drivers, and salon workers. According to Dr. Peters, “Tipped employees may also include front-of-house restaurant staff, bellhops, parking attendants, airport service workers, and food delivery workers.” These workers often rely on tips as a significant part of their income, making tipping customary in these contexts.
For services where tipping is optional, such as routine car maintenance or handyman visits, Birardi recommends a 10% to 20% tip if the service is exceptional. Alternatively, offering a meal or snack can be a budget-friendly way to show appreciation.
The Tax Implications of Tipping
Recent tax proposals from political figures like former President Donald Trump and Vice President Kamala Harris have brought tipping into the spotlight. Both have suggested making tip income tax-exempt, sparking debates on how best to support tipped workers while managing tax policy.
For example, the Senate bill, “No Tax on Tips Act,” introduced by Sen. Ted Cruz, proposes a 100% above-the-line deduction for cash tips. Another proposal, the “Tax-Free Tips Act of 2024,” aims to exempt tips from both income and payroll taxes. These proposals reflect broader discussions about tax relief and economic support but come with potential drawbacks.
The Tax Foundation points out that exempting tips from income tax could incentivize more businesses to shift from full wages to a tip-based payment approach. This shift could lead to more industries adopting a restaurant-like model where a list price is presented upfront, and a voluntary tip is expected at the end of the transaction.
Political Implications and the Ongoing Debate
As the election season approaches, tax policy discussions, including tipping practices, are taking center stage. Both Donald Trump and Kamala Harris have proposed changes that could significantly impact how tips are taxed. While these proposals aim to ease the financial burden on service workers, they also raise questions about fairness and potential consequences.
- Trump’s Proposal: Former President Trump’s tax reform includes provisions to make tips tax-free, providing immediate financial relief to service workers. However, this could lead to unintended consequences, such as increased tax evasion and wage manipulation.
- Harris’s Proposal: Vice President Kamala Harris supports a similar approach, arguing that exempting tips from taxes would benefit workers in the service industry. Critics, however, argue that this could disproportionately benefit higher earners and further complicate the tax system.
A crucial concern not addressed by either candidate is the potential impact on Social Security and Medicare. If tips are exempt from these taxes, it could affect workers’ retirement and healthcare benefits. Some Congressional bills consider this issue and do not exempt tips from payroll taxes, while others do. The final outcome remains to be seen.
Is There a Better Approach?
An alternative approach to providing tax relief might involve raising the standard deduction, which could benefit both wage earners and tipped workers. For instance, increasing the standard deduction by $6,000 could offer more broad-based relief compared to the no-tax-on-tips proposal, which may disproportionately benefit higher earners.
As Dr. Peters suggests, “You can always decide to tip a little more or less based on your financial situation and your appreciation for the service provided. The thought still counts the most.”
When It’s Okay Not to Tip
While tipping is generally expected, there are specific situations where it may be acceptable to forego a tip. Here are four scenarios:
- Poor Service: If the service doesn’t meet expectations, it might be reasonable to withhold a tip. From a tax perspective, this doesn’t affect the overall tax treatment of the service.
- Prepaid Services: For services that are prepaid, such as at an all-inclusive resort, additional tipping is typically not expected.
- Gratuity Included: Some establishments include a gratuity in the bill, especially for large parties. In such cases, additional tipping is generally not required.
- Administrative Fees: Services that include an administrative fee in their charges, like online booking platforms, often replace the need for a tip. These fees are considered taxable income by the IRS.
Conclusion
The rise of tipping at digital payment kiosks and the proposed tax changes reflect ongoing shifts in how we view and manage tipping. While the general rule of thumb remains to tip around 20% for services, it’s important to adjust based on your financial situation and the quality of service received. As the debate over tax-exempt tips continues, focusing on straightforward ways to support service workers and manage your finances effectively remains a priority.
