No Tax on Tips — NOT!

by Tom Yamachika, President, Tax Foundation Hawaii 

Last week our column focused on the “No Tax on Tips” provision in the Trump tax act.

This week we look at some news that Hawaii recently dropped.  It’s at the very end of Tax Information Release 2025-01.  It says that Hawaii General Excise Tax applies to tips.

Now, there is an exemption in the GET for gifts (HRS section 237-24(4)).  Doesn’t that apply?  After all, when I go to a restaurant and add a tip on to a check, no one is forcing me to do that.  It’s perfectly legal for me to walk out of the restaurant without leaving any tip whatsoever, as long as I pay the rest of the bill.  (Except for “compulsory gratuities,” such as when a restaurant adds 15% to the tab for a large party.  That’s considered part of the restaurant tab and isn’t really a tip in the traditional sense.)

It turns out that there is also an exemption for gifts in the income tax laws, both federal and state (IRC section 102).  But for decades, tips have been considered income, like part of wages.  This is true at the restaurant, bar, hair salon, casino, wherever tips are given.  At least in theory, employees of those establishments are supposed to let their employers know how much tips they received, and the employers are supposed to put that amount down on the employee’s W-2 form.  Why?  In Roberts v. Commissioner, 176 F.2d 221 (9th Cir. 1949), the U.S. Court of Appeals for the Ninth Circuit (which includes Hawaii) drew from precedents all over the country and ruled that a tip is “what is paid a servant in addition to the regular compensation for his service, to secure better service or in recognition of it.”  Compensation for services is income, not a gift.  This holding was reaffirmed in Olk v. Commissioner, 536 F.2d 876 (1976), which applied the same logic to “tokes,” tips received by casino dealers.

Federal precedents on what is or what is not income are not definitive as to state law – state courts decide that – but our income tax law is designed to conform to the federal income tax law, and our GET law is influenced by those meanings as well.  So, it doesn’t seem unreasonable for the Department to conclude that tips are taxable income for GET purposes as well.

Does this change the world for tipped employees?  Probably not.  An employee receiving tips is exempt from GET on those tips, but not because the tips are gifts, it’s because they are part of wages.  Wages are also exempt from GET (HRS section 237-24(6)).

But:  Employers of tipped employees must be careful to include tips in gross income.  Employees who receive tips outside of their employment should know that they are responsible for paying GET on those tips.  (Tips outside of employment would seem to include tips that an employee finds in a pants pocket and somehow forgets to inform the employer about.)

This seems to me to be a departure from past practice.  I remember a practitioner seminar several years ago when the Department’s audit staff were telling us that restaurant employers needed to pay GET on compulsory tips but not on the other kind. 

Oh, well.  I guess it just means that when the federal government says “No tax on tips,” our state comes in and says, “Fine, then give that tax money to us.”