In the realm of presidential campaigns for 2024, proposals to exempt gratuities from federal income tax have emerged, put forth by both Donald Trump and Kamala Harris. However, a recent analysis by the Tax Policy Center (TPC) suggests that only a select few employees stand to benefit from this potential change in legislation.
Limited Scope of Benefits:
1. According to TPC, a mere 2 percent of households would see a tax cut if gratuities were excluded from federal income tax.
2. Additionally, only 1.5 percent of households with adjusted gross income of $75,000 or less would benefit from this tax exemption.
3. If tips were to be exempt from both income and payroll tax without any eligibility limitations, about 3.3 percent of households would experience increased take-home pay.
Tax Implications:
– While the proposition of exempting tips from income tax might result in reducing federal revenue by $6.5 billion in 2025, limiting the benefit to individuals earning $75,000 or less would cut the loss to $3.2 billion.
– Extending the tax exemption to both income and payroll tax would escalate the 2025 cost to $13.5 billion.
Challenges and Trade-offs:
– Despite potential tax savings, workers would not contribute to Social Security and Medicare by avoiding payroll taxes, which could lead to reduced benefits during retirement.
– Among tipped workers, the average tax cut would amount to approximately $1,800 if they could deduct tips from taxable income.
Efforts to Model:
– TPC conducted analyses based on stylized versions of the proposed tax deductions suggested by Trump and Harris.
– Per this analysis, income tax deductions for tipped workers making $75,000 or less and the exemption of tips from both income and payroll taxes for all tipped workers were considered.
Income Disparities and Impact:
– Lower-income tipped workers may not receive substantial benefits from the proposed tax deductions, as many of them already pay no income taxes.
– Notably, middle-income households in the $63,000 to $113,000 income bracket stand to benefit the most from these tax reforms, with a potential average after-tax income increase of 2.8 percent.
Final Considerations:
– While the campaigns of Trump and Harris have generated significant attention, these tax ideas would have minimal relevance to the majority of households and even several tipped workers.
– TPC’s analysis, while informative, does not account for independent contractors or teenagers claimed as dependents, potentially overlooking alternative impacts of the proposed tax exemptions.
In conclusion, while the prospect of exempting gratuities from federal income tax may seem beneficial at first glance, the actual implications and beneficiaries of such policies would be far more nuanced and limited than initially anticipated.
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