How would dropping income tax on tips affect SS deductions and benefits?

[Jay968]

What is the name of your state? California

I ask this because the presidential candidates are both suggesting an end to federal taxes on tips. How would this affect both the payroll deduction and the SS benefit upon retirement?

 

[Taxing Matters]

The answer to that depends on exactly what bill they propose will say, and no one has put out a plan that detailed. Under he law as it is now, tips are taxable income as wages, and the employer is supposed to do the wage withholding for income and FICA taxes (Social Security, Medicaid, and Medicare taxes). The wages paid are then reported to SSA to add their earnings record. It is that earnings record that determines that determines what amount of benefits the worker will recieve after reaching the age for Social Security & Medicare benefits.

If all the proposals do is make tips not taxable income, then the employee doesn't have any income or FICA taxes to pay on that income and since it would not be taxable wages, the tips would not get added to their Social Security earnings record. While sound tax principles would tax the tips, if they exempt the tips then the fairest outcome would be that the tips don't get added to their SSA earnings record because they aren't contributing to the system via FICA taxes like every other worker. That may be a trade off that at least some low paid service workers would be willing to make to have more money in their pocket each month. The wages the employer pays them will still count toward the SSA earnings record, so they'd still qualify for the benefits if they work at least the minimum 40 quarters (10 years). It's just the benefits they'd get would be less than if the tips had been subject to FICA taxes to contribute into the SSA system. The Congress could make it optional: employees who want the tips to count towards SSA earnings could elect to have FICA taxes withheld from their pay, and those who want to opt of the FICA tax regime would get more cash now, but less SSA benefits later on.

 

[Jay968]

Thanks for the great response!
Makes perfect sense.

 

[LdiJ]

The answer to that depends on exactly what bill they propose will say, and no one has put out a plan that detailed. Under he law as it is now, tips are taxable income as wages, and the employer is supposed to do the wage withholding for income and FICA taxes (Social Security, Medicaid, and Medicare taxes). The wages paid are then reported to SSA to add their earnings record. It is that earnings record that determines that determines what amount of benefits the worker will recieve after reaching the age for Social Security & Medicare benefits.

If all the proposals do is make tips not taxable income, then the employee doesn't have any income or FICA taxes to pay on that income and since it would not be taxable wages, the tips would not get added to their Social Security earnings record. While sound tax principles would tax the tips, if they exempt the tips then the fairest outcome would be that the tips don't get added to their SSA earnings record because they aren't contributing to the system via FICA taxes like every other worker. That may be a trade off that at least some low paid service workers would be willing to make to have more money in their pocket each month. The wages the employer pays them will still count toward the SSA earnings record, so they'd still qualify for the benefits if they work at least the minimum 40 quarters (10 years). It's just the benefits they'd get would be less than if the tips had been subject to FICA taxes to contribute into the SSA system. The Congress could make it optional: employees who want the tips to count towards SSA earnings could elect to have FICA taxes withheld from their pay, and those who want to opt of the FICA tax regime would get more cash now, but less SSA benefits later on.

That would seriously hurt many tipped employees in the long run. The minimum wage for servers is incredibly low and would give them very little in the way of Social Security credits. It would be less damaging for incidentally tipped workers. For example, the minimum wage for tipped employees in Indiana is only $2.13 per hour.

 

[Bali Hai Again]

What is the name of your state? California

I ask this because the presidential candidates are both suggesting an end to federal taxes on tips. How would this affect both the payroll deduction and the SS benefit upon retirement?

Everyone needs to be required to pay into SS. If there is an opt out for some it should apply to everyone. This nonsense will fade away after the election.

 

[Zigner]

Everyone needs to be required to pay into SS. If there is an opt out for some it should apply to everyone. This nonsense will fade away after the election.

The proposal(s) wouldn't stop folks from paying into SS. It would simply prevent their tip income from being subject to SS tax.

 

[quincy]

Raising the minimum wage makes more sense to me than eliminating the tax on tips if the goal is to help low-income wage earners, not that I think either proposal will get enough bipartisan support in Congress as Congress currently stands.

Here is a joint study from earlier this year by the University of Michigan and Carnegie Mellon University that provides a look at some of the benefits of raising the (abysmally low) minimum wage:

https://michiganross.umich.edu/news/new-study-explores-positives-raising-minimum-wage

 

[zddoodah]

If all the proposals do is make tips not taxable income, then the employee doesn't have any income or FICA taxes to pay on that income and since it would not be taxable wages, the tips would not get added to their Social Security earnings record.

That said, couldn't the tips be exempt from federal income tax but still subject to FICA withholding? I assume the answer is yes and that doing something like this would create headaches for smaller employers who don't use payroll services.

The minimum wage for servers is incredibly low. . . . For example, the minimum wage for tipped employees in Indiana is only $2.13 per hour.

Note that the OP is in California where the minimum wage for tipped workers isn't any different than for any other employee.

 

[Taxing Matters]

That said, couldn't the tips be exempt from federal income tax but still subject to FICA withholding? I assume the answer is yes and that doing something like this would create headaches for smaller employers who don't use payroll services.

Yes, Congress could do that too. There are already some types of pay/benefits from employment that are excluded from income but are still subject to FICA taxes as well. Depending on the wage the employee is making, however, that might not help a whole lot.

Note that the OP is in California where the minimum wage for tipped workers isn't any different than for any other employee.

In that case, the employee is much better than tipped in most other states.

 

[quincy]

That said, couldn't the tips be exempt from federal income tax but still subject to FICA withholding? I assume the answer is yes and that doing something like this would create headaches for smaller employers who don't use payroll services.




Note that the OP is in California where the minimum wage for tipped workers isn't any different than for any other employee.

The no-tax-on-tips would apply to states nationwide.

 

[davew9128]

Good lord. Why is this nonsense even being discussed?

 

[Taxing Matters]

Good lord. Why is this nonsense even being discussed?

I think the answer to that is, even if it is unlikely that Congress would pass the proposal, both Trump and Harris have put this idea out there as part of their platform which raises the likelihood that whomever is elected the proposal would at least get introduced into Congress. Some may feel differently, but I don't see a problem discussing real potential legislation as those are also legal issues clients have to be concerned about. In short, I don't see it as "nonsense" as you do.

 

[davew9128]

I think the answer to that is, even if it is unlikely that Congress would pass the proposal, both Trump and Harris have put this idea out there as part of their platform which raises the likelihood that whomever is elected the proposal would at least get introduced into Congress. Some may feel differently, but I don't see a problem discussing real potential legislation as those are also legal issues clients have to be concerned about. In short, I don't see it as "nonsense" as you do.

I disagree. Unless there is a serious probability (not mere possibility) of something being enacted into law, this is a distraction from the professional side of things. I don't entertain or engage clients in these types of conversations even if it leads to billable time playing the role of Dr. Frasier Crane.

Part of advising clients is not falling prey to TikTok sound bites.

 

[Taxing Matters]

I disagree.

That's ok, we don't have to share the same opinion.

Part of advising clients is not falling prey to TikTok sound bites.

But we aren't advising clients in this forum and aren't billing anyone for the explanations we provide. When advising clients I approach these kinds of questions differently than I do here. I totally understand if you think it's a waste of YOUR time to engage in these kinds of threads on this forum. So go ahead and skip them. I happen to take a different view of it. If I want to dive into it, it's no skin off your nose, right? There's not a right or wrong to this; it's just personal preferences at work.

 

[quincy]

… Unless there is a serious probability (not mere possibility) of something being enacted into law, this is a distraction from the professional side of things. I don't entertain or engage clients in these types of conversations even if it leads to billable time playing the role of Dr. Frasier Crane.

Part of advising clients is not falling prey to TikTok sound bites.

We generally don’t and won’t entertain hypotheticals on this forum and we are not a discussion forum, so I understand your comments, davew9128. Anything we say about eliminating the taxes on tips will be guesses at best since the presidential candidates have not provided any detailed plans and we have no idea if any such tax plan will be enacted anyway. I suspect it won’t.

That said, some of us will sometimes veer from the purpose of this forum, which is to help a poster with their current real life legal issues, because a) a topic happens to interest us; b) we’re bored (); c) we ran across a cool research study that we wanted to share and this seemed as good a place as any to link to it ( ).