Senate approves $25,000 tax cut for tipped workers
The Senate unanimously passed a bill that would allow tipped workers to deduct up to $25,000 in cash tips from their taxable income.
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Experts said a “tip tax exemption” could have the unintended consequence of unlocking part of the American dream for 4 million Americans.
Experts say workers will be able to report up to $25,000 in tip income on their tax returns without fear of paying taxes, increasing the amount of reported income lenders use to calculate their debt-to-income (DTI) ratios. DTI is used by the Federal Housing Administration as an important criterion for mortgage loan approval.
“This is a really big change for residents who work in the tipping economy,” said Sam Lundy, chief executive officer of UMH Properties, which operates manufactured housing communities. “They will have even more access to funding.”
How can FHA mortgages be possible if there is no tax on tips?
FHA typically allows people with up to 31% DTI (Delivery Ratio) to secure a mortgage. Up to 31% of your income goes toward housing costs, including mortgage payments, taxes, and insurance.
Mr. Lundy showed how the math works for a couple with two children and a tipped wage.
- Before tips were taxed, his monthly income in 2024 was reported to have totaled $2,750, including tip income. A decent home with a monthly cost of $1,200 would have a DTI ratio of 43.6%, well above the FHA limit of 31%. In this scenario, your mortgage loan will be denied.
- Under “no tax on tips,” the same couple could each declare $25,000 of annual tip income without tax consequences, increasing their total monthly income to about $4,833. The DTI ratio for the same home drops to 24.8%, well below the FHA threshold. In that scenario, your mortgage loan will be approved.
Is this a gimmick?
This is not unlike the mortgage crisis of 2007-2008, when lending standards were relaxed and people with bad credit were able to borrow.
Rather, it’s “just a policy change that allows people to take full ownership of the money they earn, pay less in taxes, and have more money to buy the American Dream,” said Eric Steffey, a federal benefits expert and founding CEO of Federal Solutions Support.
For example, people who could take advantage of the lack of taxes on tips to increase their income and qualify for FHA loans are those currently renting in Lundy housing communities.
He said his community maintains a 95% occupancy rate, a 98% rent collection rate, and low turnover, indicating that people there have stable incomes and good payment histories. The only thing holding them back from buying a home is likely the DTI requirement, Lundy said.
“Things are moving in the right direction now,” he said.
Not only will your rent payment history be included in your credit score calculations, but “the fact that tips aren’t taxed gives you an incentive to record and track your tips because there’s no federal tax penalty,” Lundy said.
Are there any pitfalls?
Steffey said workers are not automatically eligible for FHA loans. FHA loans typically require two years of steady employment and income history, so you may still have to wait a year or so.
But Steffey said: “It’s great that the 2.5 per cent of bartenders, servers and other tipped workers now have some hope because they can now own something rather than rent.”
Make the most of your waiting time
While people may be disappointed in having to wait to receive an FHA loan, Steffey said they should focus on the goal of eventually being able to purchase a home and use their time productively.
“Start saving, make a plan, and talk to your mortgage loan officer,” he said.
FHA also takes into account the “back-end DTI,” which measures how much a person’s income is relative to their total debt, which includes not only their mortgage and home-related payments, but also other debts such as car, student loans, and credit card payments. Typically, the maximum value for FHA is 43% of backend DTI.
To ensure this is achieved, Steffey said using the savings from not paying taxes on your tips while you wait to pay down debt or save money for a larger down payment will ensure a smooth and secure home purchase.
If people follow the steps, the tax exemption on tips could “enable 4 million people to buy or upgrade their first home,” Steffey said.
Medora Lee is USA TODAY’s money, markets and personal finance reporter. Please contact us at mjlee@usatoday.com. Subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday.
