Michael Chittenden’s commentary was included in a Tax Notes article examining the real-world impact of the federal “No Tax on Tips” deduction one year after its enactment and workers’ initial confusion.
Some initial confusion from workers may have stemmed from the expectation that they would immediately see their paychecks go up when the deduction was enacted, Michael noted. But Michael explained that didn’t happen because there wasn’t a change to withholding tables to account for the deduction until 2026.
“As a result, I think there was maybe some disenchantment on the part of some employees up front,” Michael stated.
Michael pointed out that the new Form W-4 allows employees to estimate the amount of tips they’ll receive and provides instructions to the employer on how to adjust the withholding. However, unless workers are monitoring their tips, those estimated withholding amounts could be too high or too low, which could result in a large refund or a large tax bill come next year, Michael said.
Michael also commented on the automatic gratuity exclusion, which was another source of confusion for workers. While larger and more sophisticated employers have a good understanding of what is and isn’t an automatic gratuity, workers may not possess that same understanding of how to properly classify a tip as voluntary or automatic, which could add confusion for the worker when looking to claim their tips as a deduction, Michael explained.
Workers also may have found the differences between the state and federal tax treatments of tips confusing. “I don’t know that there’s necessarily an understanding on employees’ parts across the board that there can be a large gap in their taxable income at the state and federal levels,” Michael said.
One open question has been whether the tips deduction will increase self-reporting of tips. According to Michael, there are benefits for workers to report tips. “If they need to qualify to rent an apartment, buy a house, buy a car, get a loan, all of those things, having accurate income reporting is critical to those things.”
While Michael said that large employers have done a good job informing their employees about the importance of reporting tips and teaching them how the qualified tips deduction works, he suggested that an employer’s advice may only be so helpful to a taxpayer.
“As a general rule, employers are not keen on being seen as giving tax advice to their employees,” Michael said. “They’re not equipped to do that, and so anything they’re telling the employees is going to be necessarily general in nature,” he added.
Michael also said that the tips deduction has introduced more responsibilities for large employers and highlighted a few key changes. For example, some employees with multiple jobs might work one job that receives tips, and one job that doesn’t, which means that the employer must keep track of that distinction for reporting the tip occupation code and the tip amounts for Forms W-2, Michael added.
Further, Michael also said that the nonconformity between state taxes and federal taxes regarding tips is another aspect for employers to be aware of because they must program into their system that an employee’s tips are to remain taxable at the state level.
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