Tips and overtime could be exempted from federal income tax. Here’s what it would look like for Iowa

As the reconciliation bill nears the finish line in Congress, provisions exempting tips and overtime from federal income tax could become a reality for workers across the country, including for Iowans.

The policy received bipartisan support during the 2024 election, with support from both then-candidate President Donald Trump and former Vice President Kamala Harris as a way to help service industry workers, including servers, bartenders and hospitality workers.

While both chambers include the provisions in their version of the bill, the measures differ. Under the House version, only people with annual income of $160,000 or less would qualify for the tip tax exemption, and deduction limits would be uncapped. The Senate version, which includes a $25,000 deduction cap, would phase out for people with incomes over $150,000 or couples with incomes over $300,000.

Under the provisions, qualifying workers could exempt tips and overtime pay from their taxable income each year spanning from Dec. 31, 2024, through 2028. If the tax and spending package passes, the U.S. Treasury Department would be required to determine which tipped workers will be eligible for the tax cuts.

The Senate passed its version of the reconciliation bill Tuesday, 51-50, with Vice President JD Vance casting a tie-breaking vote in favor. As of Wednesday evening, the House is considering the version passed by the Senate, after passing its own version in May.

Nationally, roughly 4 million workers, or less than 3 percent of the U.S workforce, regularly earn tips through their jobs, according to the Budget Lab at Yale University.

Iowa Restaurant Association President and CEO Jessica Dunker said while the exemption won’t directly benefit restaurants, it will help tipped workers.

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“The restaurant industry, generally, has been very supportive of the no tax on tips legislation, because it really helps a segment of our workforce population to keep more money,” Dunker said. “From the standpoint of a restaurant business, no tax on tips really doesn't have any impact to their business bottom line, and that's OK, just because the bill also keeps the tip credit in place.”

While the White House’s Council of Economic Advisers estimates that eliminating taxes on tips would increase eligible average take-home pay by $1,675 per year, other economists say it wouldn’t affect most working-class Americans and would add to the federal deficit.

Under the Senate’s proposal, the provision exempting tips from federal income tax could reduce federal revenues by $32 billion from 2025 through 2028, according to an analysis by the nonpartisan Congressional Budget Office. The provision exempting overtime pay from the federal income tax could reduce federal revenues by $90 billion.

William Boal, an economics professor at Drake University, said tax cuts for tips and overtime would add to the federal deficit or put less funding toward government services.

“It always sounds good to cut taxes ... but something's got to give somewhere else when you cut taxes,” Boal said. “This is not a huge cut in taxes that we're talking about when we talk about tips and overtime, but if you cut taxes, then something else has to give, and that means either government services have to decline or the deficit goes up.”

What will the provisions look like for workers?

Service industry tips are taxed because they are considered part of income, but over a third of tipped workers don't make enough to pay any federal income taxes, according to the Budget Lab at Yale University.

Tax cuts would also vary among service industry workers depending on whether their position is tipped or not. For example, servers at restaurants would qualify for the tax break, but fast-food workers who make similar wages would not.

Boal said that although the proposed tax breaks would help some working-class Americans, the benefits would touch only a fraction of workers.

“People who are working part time in restaurants and so forth, there's a good chance that they're hardly paying any in taxes already … that's not a big deal for them,” Boal said. “If you were going to try to help out working people, there's more straightforward ways of doing it that would cover everybody. You know, you could increase the standard deduction, or you could lower the marginal tax rates at the bottom.”

Will Iowa see state income tax cuts on tips, overtime pay?

During the 2025 legislative session, proposals to cut state income tax on tips and overtime pay were introduced by Republicans and Democrats, but none of the bills made it across the finish line.

Under House File 293 and House File 268, identical bills introduced by Democratic state Rep. Dave Jacoby, of Coralville, and Republican Rep. David Young, of Van Meter, respectively, all earned income from cash tips would be exempt from Iowa’s 3.8 percent flat income tax rate.

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Iowa’s minimum wage is set at the federal minimum of $7.25 an hour. For tipped workers who make more than $30 in tips per month, the minimum wage is $4.35 an hour.

House File 360 and House File 110, introduced by Democratic Rep. Jeff Cooling, of Cedar Rapids, and Republican Rep. Mike Sexton, of Rockwell City, respectively, would have exempted overtime pay from state income taxes.

Iowa lawmakers would need to pass legislation adopting the tip exemption for it to apply to state income taxes, according to the Tax Policy Center.

Jacoby said the federal cuts will put more money back into the pockets of working Iowans.

“It gives you money to live, money for rent, car payments, tuition,” Jacoby said.

Jacoby added he hopes to couple a state exemption with the new federal exemption when the Iowa Legislature reconvenes next year and make it apply retroactive to January 2025 to ensure Iowans won’t pay more in state income tax if they receive the federal tax cut.