Illinois rejects federal ‘no tax on tips’ rule, keeps state tax on tipped income

By Catrina Barker | The Center Square contributor
The Center Square

(The Center Square) – Illinois is not adopting the new federal “no tax on tips” provision, meaning tipped workers in the state will still owe Illinois income tax on tips, even when those tips are exempt at the federal level.

Manish Bhatt, senior policy analyst with the Tax Foundation, said Illinois’ tax structure makes it possible for the state to decline the new tip exemption.

“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. “I don’t believe Illinois does that. So I think the states are certainly able to not incorporate that individual sort of exemption on tips and overtime wages.”

Even for states that do automatically conform to federal tax changes, Bhatt said it may be wiser to “decouple” from the federal rule.

“It’s much more sound tax policy to not create carve-outs for certain taxpayers at the expense of others,” he said. “More general reform certainly needs to happen to bring the tax burden down for everybody.”

Bhatt said taxpayers who are seeing and hearing about the no tax on tips at the federal level might not think about having to actually add those back into their state return.

“It’s not that those individuals are trying to avoid taxation. They just don’t know to add that back into their state income tax,” Bhatt told The Center Square.

Bhatt warned that confusion could lead to filing mistakes or the need for paid tax preparation services.

“If these individuals now have to hire a professional tax preparer when they were otherwise doing it at home by themselves,” he said, “there’s a number of inefficiencies … that lawmakers need to be aware of.”

Illinois remains a high-tax state, with one of the nation’s highest property tax burdens. Bhatt acknowledged that it may be difficult to persuade a tipped worker, already facing rising tax pressures, that opting out of the exemption is sound policy.

“This is an example where good politics doesn’t always make good policy,” he said. “When you create a carve-out for a certain industry or a certain company, you’re shifting the burden onto somebody else.”

Illinois, he said, should instead pursue broad-based reform that benefits all taxpayers—not just certain groups.

“Lawmakers should prioritize sound and broad tax reform in the state so that everybody benefits,” he said.

Bhatt emphasized that while not taxing tips may sound attractive to workers, selective exemptions distort the tax code.

“You could have two workers earning the same salary but facing different tax burdens simply because of the nature of their jobs and how they’re paid,” he said.

He offered a simple example: a bank teller and a waiter each earning $30,000 in a hypothetical flat-tax state. Under a no-tax-on-tips system, the waiter would pay dramatically less than the teller—even though they take home the same amount.

The imbalance could also push employers to restructure compensation.

“If this is implemented around the country, there will be the incentive for employers to shift the way that their workers earn their money,” Bhatt said. Some industries may try to shift employees into tip-eligible roles “to attract and retain workers on the promise of a lower tax bill.”