The State of Illinois has decided not to embrace the federal government's exemption on taxing tips, a move that will have significant implications for tipped workers throughout the state. President Donald Trump's administration has deemed taxing tips to be inappropriate, leading to a policy change at the federal level. However, Illinois has taken a divergent path, continuing to tax tipped income at the state level.
According to Manish Bhatt, a senior policy analyst at the Tax Foundation, Illinois does not conform to federal tax definitions, thereby maintaining its own set of rules for what constitutes taxable income. "Only those states that begin state-level income tax calculations using the federal definition of taxable income have it automatically incorporated into the tax code," Bhatt explained to The Center Square. He highlighted that Illinois' stance allows for state discretion, but it also introduces a lack of uniformity in how tip income is taxed across the nation.
The decision underscores the complexity of tax policy and its real-world impact on employees and employers alike. Tipped workers in Illinois may now be at a disadvantage compared to those in states that align more closely with the federal tax code. For instance, Colorado uses federal taxable income as a benchmark, potentially benefiting from the federal tip exemption. Conversely, California and New York calculate state taxes based on federal adjusted gross income (AGI), which may not include such exemptions.
This disparity raises questions about equity and fairness. Bhatt warned that the lack of awareness regarding state-specific tax requirements could lead to errors in tax returns, with workers inadvertently failing to declare tips as income and thus facing penalties. This confusion might push more individuals to seek professional tax preparation services, incurring additional costs.
Moreover, the policy could inadvertently influence employer practices. Some businesses might adjust their compensation strategies or reclassify employees to capitalize on more favorable tax treatments. This could reshape industry pay structures, with positions that qualify for tips becoming more strategic in attracting and retaining staff.
Bhatt emphasized the importance of equitable tax reform, cautioning against creating selective exemptions that benefit some taxpayers over others. "It's much more sound tax policy to not create carve-outs for certain taxpayers at the expense of others," he stated. Instead, he advocates for comprehensive tax reforms that would reduce the tax burden for all taxpayers.
The issue is further complicated by Illinois' high property tax rates, which add another layer of financial strain on residents. Bhatt acknowledged the challenge in convincing taxpayers that separating state policy from federal exemptions is beneficial in the long run. He urged state lawmakers to focus on broad-based, equitable tax reforms rather than narrow exemptions that could shift the tax burden onto others.
In a tweet from the account Libs Of Chicago, the frustration with the Illinois policy was evident. The tweet criticized Governor Pritzker's decision not to follow the federal lead on tipping taxation, suggesting an opposition to letting residents keep more of their earned income.
