Early on in my career, I started going out for lunches and dinners with key contacts and clients. Providing gratuities, or tips as they’re better known, for good service was, of course, customary. I wondered if it was a requirement for the servers to pay tax on their received tips. The short answer was yes and still is.

I also learned that the reporting of tip income by recipients is very inconsistent and the subject of myths. A number of people, even seasoned tax professionals, would tell me — and continue to do so — that as long as the recipients reported something, say 10 per cent of their wage, the

Canada Revenue Agency (CRA)

would leave them alone. Not true and never has been.

The CRA has long provided

administrative guidance

about the requirement to report tip income. For employers, especially if the tips are originally in their control, the CRA has

provided guidance

regarding proper tax withholdings from such amounts. Tips are indeed taxable income and need to be reported in their entirety.

For the recipient, there are often good reasons to fully report your tip income.

The first is that you’re breaking the law by purposely not reporting it. In a worst-case scenario, it could be considered criminal tax evasion, resulting in significant financial penalties and possible jail time. Don’t purposely under-report.

Second, the reporting of your tip income can possibly make you eligible for certain types of government programs. For example, I’m aware of some servers who didn’t report their tip income, so their income was too low to qualify for all the government handouts when COVID-19 came along.

Third, it increases your

registered retirement savings plan (RRSP)

contribution room and future

Canada Pension Plan

payouts.

Lastly, it can increase your income for the purposes of loan and mortgage eligibility.

A basic policy in the design of any country’s tax system is that any economic enrichment received by a taxpayer is taxed. The exceptions to such a basic rule are what cause many of the complications.

For example, in Canada, lottery winnings are not taxable; only one-half of capital gains are included in taxable income; and dividend income received by individuals is taxed at a lower overall rate to give credit for the underlying corporate tax that has already been paid on such distributions. These are all deliberate policy choices.

Tip income has intentionally not been excluded from being subject to tax in Canada. That is correct. There aren’t any good and obvious policy reasons to exclude tips from tax.

That’s why I was surprised when

Donald Trump

promised to introduce a rule to not tax tips and overtime in the United States during the election campaign last year. I guffawed at such a promise since, again, I couldn’t understand any good tax policy reasons to do that.

I also wondered how such a law, if implemented, would be administered and to what occupations such an exclusion would apply. For example, perhaps a lawyer could issue an invoice for services rendered for US$100, but mandate a non-taxable “tip” of US$100,000. Would the law encourage that kind of abuse?

Fast forward to the implementation of Trump’s

One Big Beautiful Bill Act

that became U.S. law on July 4. It implemented the election promise, but didn’t give a free pass on all tips. It also implemented limited non-taxability on overtime pay as well.

Under new Internal Revenue Service code section 70201, for 2025 through 2028, employees and self-employed individuals may deduct up to US$25,000 of qualified tips (voluntary cash or charged tips received from customers or through tip sharing) received in occupations listed by the tax agency as customarily and regularly receiving qualified tips.

For self-employed individuals, the deduction can not exceed their net income. The deduction phases out for those that have adjusted gross income in excess of US$150,000 or US$300,000 for joint filers.

The IRS has not yet provided its list of occupations that “customarily and regularly” receive tips and has until Oct. 2, 2025, to do that. Obviously, that list will be narrow to try to curtail some of the abuses that could be done, as illustrated in the example above.

Should Canada do something similar? No. The new U.S. rule is very silly and a blatant example of politics driving tax policy for votes.

Does it make any sense that a person who customarily receives tips should not pay tax on such amounts, whereas a person working in another industry — such as a retail sporting goods store — will pay tax on their compensation? No, it makes zero sense. If that makes sense to you, well, I have a bridge for sale down the street. Let’s chat.

There are obvious administrative benefits to exempting tips from tax (tips are usually small dollar amounts and can be a nuisance to track) and equity arguments (tips are often earned by lower-income people, so exempting such tips from income tax can perhaps improve equity), but the real risk is the erosion of the tax system.

In other words, instead of relying on existing exemptions and credits to exempt and/or reduce lower-income households from tax, having no tax on tips would encourage no tax on other types of income. It would be a slippery slope.

As former U.S. president Ronald Reagan once quipped, “The most terrifying words in the English language are: ‘I’m from the government and I’m here to help.’”

  • Canada should take another look at how it taxes death
  • Canada’s personal tax rates need to come down

Is the U.S. government helping by complicating their tax laws with non-principled carveouts that are not grounded in good tax policy? If Canada followed suit, what’s next?

The tax system works best when it’s clear, consistent and based on sound policy, not vote-hunting gimmicks. Canada should keep tips on the serving tax table.

Kim Moody, FCPA, FCA, TEP, is the founder of Moodys Tax/Moodys Private Client, a former chair of the Canadian Tax Foundation, former chair of the Society of Estate Practitioners (Canada) and has held many other leadership positions in the Canadian tax community. He can be reached at kgcm@kimgcmoody.com and his LinkedIn profile is https://www.linkedin.com/in/kimgcmoody.

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