Does California tax tips?

Have more questions?

Reviewer

Casey Epton, CPA, is a Senior Tax Advisor at Deduction, where he helped design Taylor, CPAI from day one, building an AI tax agent that works seamlessly for both clients and the CPAs who verify every return.

Last updated:

Sep 2026

Yes. Tips are considered taxable wages in California and are subject to California Personal Income Tax (PIT), just like regular wages.

1. How California Treats Tips - Types of Tips Covered

California follows federal tax law in classifying tips as taxable compensation. All of the following are treated as wages subject to California PIT:

Cash tips received directly from customers
Tips paid by credit or debit card and passed through by the employer
Tips received through a tip pool or tip-sharing arrangement

Tips must be reported by the employee to their employer (for amounts of $20 or more in a calendar month), included in the employee's taxable wages, and reported by the employer on Form W-2, Box 1 (federal wages) and Box 16 (state wages, tips, etc.).

2. California Payroll Tax Treatment of Tips

Tips that constitute wages are subject to the following California payroll taxes:

California Personal Income Tax (PIT) withholding - yes, subject
State Disability Insurance (SDI) - yes, subject (see correction below)
Unemployment Insurance (UI) - subject for most employees; consult EDD DE 231TP for specific exemptions by payment type
Employment Training Tax (ETT) - subject for most employees (employer-paid, applies to first $7,000 in wages)

Tips are also subject to federal Social Security and Medicare (FICA) taxes at 7.65% combined employee rate, this is unchanged and is not affected by the new federal deduction described in Section 5 below.

3. Employee Reporting Requirements

Employees who receive $20 or more in tips in a calendar month must report the total to their employer by the 10th day of the following month. Employers include reported tips in the employee's gross wages for withholding purposes, report them on Form W-2, and remit applicable payroll taxes to federal and state authorities.

Unreported tips (tips not reported to an employer) are still taxable income and must be reported directly on the employee's individual tax return using IRS Form 4137 (Social Security and Medicare Tax on Unreported Tip Income). California taxes unreported tips in the same manner.

4. California Tax Return Reporting

Tips are reported as part of total wages on California Form 540. There is no separate line item for tip income on the California return — tips flow through as part of wages from Box 16 of Form W-2. The California Franchise Tax Board receives wage and withholding data directly from the EDD and matches it to individual returns.

5. New Federal 'No Tax on Tips' Deduction - Does NOT Apply in California

Effective for tax years 2025 through 2028, the One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025 (Public Law 119-21), created a new federal income tax deduction for qualified tip income under IRC §224. Key terms of the federal deduction:

Eligible workers in occupations that customarily and regularly received tips as of December 31, 2024 (approximately 68 IRS-designated occupations) may deduct up to $25,000 in qualified tips from federal taxable income
The deduction is above-the-line and available to both itemizers and non-itemizers
It phases out for single filers with MAGI above $150,000 and joint filers above $300,000
Qualified tips are voluntary cash or charged tips — mandatory service charges do not qualify
The deduction is temporary and expires after December 31, 2028
Federal FICA taxes (Social Security and Medicare) still apply to tip income — the deduction does not eliminate payroll taxes

6. Common Misconceptions

Misconception 1: 'Tips are not subject to California SDI.' FALSE. As of January 1, 2024, all wages — including tips — are subject to California SDI withholding at 1.2% (2025 rate). There is no wage cap.

Misconception 2: 'The federal No Tax on Tips law applies in California.' FALSE. California does not conform to the OBBBA. Tips remain fully taxable for California income tax purposes. California workers must add the federal tip deduction back on Schedule CA.

Misconception 3: 'FICA taxes no longer apply to tips because of the new federal law.' FALSE. The federal No Tax on Tips provision is an income tax deduction only. Social Security and Medicare taxes continue to apply to all tip wages at the employee rate of 7.65%.

Quick Summary

Tips are taxable wages in California — fully subject to California PIT
Tips are subject to California SDI withholding (1.2% in 2025; no wage cap) — corrected from prior guidance
Effective January 1, 2026, the California SDI (which includes Paid Family Leave) withholding rate is 1.3%.
Tips are generally subject to UI and ETT (employer-paid; consult DE 231TP for specific payment-type rules)
Tips are subject to federal FICA taxes (Social Security + Medicare) — unchanged
Federal 'No Tax on Tips' deduction (up to $25,000) is available for qualifying workers for TY2025–2028
California does NOT conform to this federal deduction — tips remain fully taxable on Form 540
California workers who claim the federal tip deduction must add it back on Schedule CA (540)

Have a question about your taxes?

Ask Taylor, CPAI

Become a client