AB1443 would, for taxable years beginning January 1, 2026 and before January 1, 2031, exclude customer tips from gross income for California personal income tax purposes and remove tips from the state definitions of wages used for income tax withholding, unemployment insurance, and the employment training tax. The bill defines “tips” broadly as any gratuity provided by a customer or client, makes conforming changes across the Revenue and Taxation Code and the Unemployment Insurance Code, and builds in specific reporting and performance indicators tied to the new tax expenditure.
The change increases net pay for tipped workers at the state level and reduces the payroll-tax base that funds unemployment and training programs; it also creates immediate operational and reporting work for employers, payroll vendors, and state tax and labor agencies. The bill is temporary and reverses those changes by making several provisions operative again on January 1, 2031, which adds a second phase of implementation work at the sunset date.
At a Glance
What It Does
The bill excludes tips from California gross income and from the statutory definition of wages for withholding, unemployment insurance, and employment training tax for taxable years beginning on or after January 1, 2026 and before January 1, 2031. It also modifies state conformity with federal law to treat tips as property transferred by gift and inserts reporting and performance requirements for the Franchise Tax Board.
Who It Affects
Tipped workers in restaurants, bars, hospitality, personal care, and similar industries, plus their employers and payroll vendors. State agencies—primarily the Franchise Tax Board and Employment Development Department—must update withholding tables, information reporting, and unemployment tax calculations. Payroll software and benefits administrators must segregate tips from other wages.
Why It Matters
This creates a state-federal divergence on tip taxation, immediately increasing take-home pay for tipped workers while shrinking the state payroll-tax base that funds unemployment and training. The temporary five-year window also forces agencies and businesses to implement and later unwind technical changes, creating compliance and administrative costs.
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What This Bill Actually Does
AB1443 rewrites how California treats customer gratuities for state tax and payroll purposes for a limited period. From 2026 through tax year 2030 the bill removes tips from the state's definition of gross income, so tipped amounts that customers pay would not be included on California personal income tax returns.
At the same time the bill removes tips from the definition of “wages” for state income tax withholding, unemployment insurance contributions, and the employment training tax. The operative text defines tips simply as any gratuity provided by a customer or client.
To accomplish that, the bill inserts a temporary exclusion into the Revenue and Taxation Code (Section 17131.18.5) and alters multiple conformity provisions so that state law departs from federal law in treating tips. It changes withholding rules by excluding tips from the statutory definition of supplemental wages and instructs the Franchise Tax Board to prepare wage-withholding tables and related rules that reflect the new treatment.
For unemployment insurance, the bill amends the Unemployment Insurance Code’s definition of “wages” to exclude tips for the same 2026–2030 window, and then separately reintroduces operative text that will restore the prior definition on January 1, 2031, effectively making the exclusion temporary.The bill also addresses reporting and oversight. It removes certain federal information-reporting references for the 2026–2030 period and requires the Franchise Tax Board to track the number of returns claiming the exemption and to produce a report to the Legislature (with limited disclosure exceptions) by December 1, 2036.
Finally, the bill staggers operative dates and uses repeals-and-readds to create an explicit sunset and a built-in reversion on January 1, 2031, which means employers, payroll vendors, and state agencies will face two rounds of system changes: one to implement the exclusion and one to reverse it.
The Five Things You Need to Know
The exclusion runs only for taxable years beginning on or after January 1, 2026 and before January 1, 2031 (the text expressly repeals the change as of January 1, 2031).
The bill modifies state conformity with Internal Revenue Code Section 102(a) to treat tips as property transferred by gift for California purposes (Section 17132.6).
For withholding, the bill excludes tips from the statute’s definition of “supplemental wages,” and it suspends application of Section 6041(e) of the Internal Revenue Code at the state level for 2026–2030, changing information-reporting triggers (amendment to Section 18663 and 18631).
The Unemployment Insurance Code’s definition of “wages” is amended to exclude tips for the same five-year window (multiple changes to Sections 940, 13009, 13009.5, 13027, and 13055), with duplicate provisions set to become operative or be restored on January 1, 2031.
The Franchise Tax Board must report to the Legislature, no later than December 1, 2036, on the number of returns claiming the exclusion; that reporting requirement is treated as an exception to a taxpayer-disclosure provision and becomes inoperative on December 1, 2040 (Section 17131.18.5).
Section-by-Section Breakdown
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Temporary exclusion of tips from California gross income
This new provision removes tips from gross income for California personal income tax for taxable years 2026–2030 and defines “tips” as any gratuity from a customer or client. It also requires the Legislature to track the goal (helping individuals retain earnings) and sets the number of returns claiming the exemption as the performance indicator. Practically, this creates a direct state tax benefit for anyone who receives and reports tips, but only for the temporary period the statute covers.
State modification of federal gift rule for tips
This section modifies state conformity to federal law by declaring that, for the specified taxable years, IRC Section 102(a) will be treated to mean tips are property transferred by gift. That is a legal workaround: the state is deliberately diverging from federal definitions to justify excluding tips from state taxable income. The practical implication is a state-federal mismatch—tax preparers must compute state and federal taxable income differently for the same tipped amounts.
Withholding tables and supplemental wages: tips excluded
The bill directs the Franchise Tax Board to continue publishing withholding tables but amends the supplemental-wages rules to exclude tips for 2026–2030. It defines supplemental wages, confirms the existing supplemental withholding rates remain in statute, but instructs that tips are not supplemental wages for state withholding. Employers will therefore need to adjust payroll withholding logic so that tips are not included in state withholding calculations, even though they may still be subject to federal withholding.
Temporary removal of tips from UI wage base and reporting changes
These coordinated amendments remove tips from the definition of “wages” used to calculate employer and employee UI contributions and to determine reportable wages for certain employer filings for the 2026–2030 period. The bill also repeals and re-adds parallel provisions with operative dates set to January 1, 2031, so the original wage definition (including tips) is restored at that time. Separate changes adjust when employees must furnish written tip statements to employers and when employers may withhold related taxes—many of those procedural provisions are set to become operative again in 2031, forcing another implementation wave.
Information-reporting adjustments for payers
The bill amends the list of federal informational-return sections that must be filed with the Franchise Tax Board and explicitly states that, for taxable years 2026–2030, Section 6041(e) of the Internal Revenue Code shall not apply at the state level. That reduces certain state-level information-reporting obligations tied to payments for services during the temporary window, but it also creates potential confusion because federal reporting requirements remain unchanged.
Performance indicators and FTB reporting requirement
Beyond the tax change itself, the bill imposes a statutory reporting obligation on the Franchise Tax Board: by December 1, 2036 the FTB must report to the Legislature on the number of returns claiming the exemption, to the extent data is available. The statute treats that disclosure as an exception to a taxpayer confidentiality provision and makes the reporting requirement inoperative after December 1, 2040. That reporting timeline is unusually distant from the five-year tax window and raises questions about what data will be retained and how useful it will be for near-term evaluation.
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Every bill creates winners and losers. Here's who stands to gain and who bears the cost.
Who Benefits
- Tipped workers (servers, bartenders, hairdressers, valets): They keep more take-home pay at the state level because tips are excluded from state taxable income and, for the period, from state withholding calculations.
- Employers with large tipped payrolls (restaurants, bars, hospitality): Employers’ taxable wage base for state unemployment and employment training taxes shrinks, lowering employer payroll-tax liabilities during the five-year window.
- Small businesses with tipped staff: Reduced state payroll-tax exposure may improve short-term cash flow compared with unchanged federal obligations.
- Payroll vendors and payroll service providers (commercial payroll processors): Vendors that can rapidly implement the necessary changes may gain new business from clients seeking compliance help and updated tax tables.
Who Bears the Cost
- State government (Franchise Tax Board and Employment Development Department): Reduced tax receipts and training/unemployment contributions create a fiscal cost; both agencies must retool withholding tables, reporting systems, and IT to implement and later reverse the changes.
- Employers and payroll teams: Costs to update payroll systems, retrain staff, and maintain separate state and federal reporting paths; smaller employers without outsourced payroll face disproportionate administrative burdens.
- Unemployment Trust Fund and program beneficiaries: A shrinking wage base can reduce contributions that support UI and training programs, potentially straining program funding or shifting costs elsewhere.
- Taxpayers generally: The state revenue loss from excluding tips must be absorbed—either by reducing services, drawing down reserves, or shifting tax burdens elsewhere.
- Compliance and enforcement functions: Increased risk of underreporting of tips raises enforcement costs for state agencies and may require audits or new verification systems.
Key Issues
The Core Tension
The core dilemma is straightforward: increase low-paid workers’ take-home pay by excluding tips at the state level, or preserve the payroll-tax base that funds unemployment and training programs and maintain simpler conformity with federal tax law—AB1443 tries to do the former but, in doing so, creates fiscal pressure, administrative complexity, and a state-federal compliance mismatch with no simple fix.
AB1443 creates a deliberate and material divergence between state and federal tax treatment of tips. Federally, tips remain taxable income and subject to federal withholding and reporting rules; California’s temporary exclusion therefore forces dual treatment of the same receipts.
That mismatch drives operational complexity: payroll systems must segregate amounts subject to federal tax from amounts subject to state tax, and preparers must reconcile state returns that omit amounts still appearing on federal returns. Employers will need clear guidance on when state withholding stops and federal withholding continues.
Removing tips from the UI wage base reduces contributions that fund unemployment and training programs, producing an immediate benefit to employers and tipped workers but creating a persistent fiscal trade-off. The bill provides for only one basic performance metric—the number of returns claiming the exemption—and schedules the FTB report for December 1, 2036, well after the exclusion sunsets.
That delayed analytics window undercuts real-time policy evaluation and leaves questions about how the state will monitor impacts on UI solvency, employer contributions, and recipient benefit calculations during the enacted period. The temporary nature also compounds costs: agencies and private payroll providers must both implement and later reverse technical changes, multiplying compliance and IT expenses.
Practical enforcement is uncertain. The law depends on employees furnishing written tip statements and on employers segregating tips in payroll, but cash tips, pooling, and informal splitting arrangements complicate measurement.
With tips excluded for state purposes but taxable federally, there is an incentive to shift compensation forms or underreport tips to game state liability; detecting that behavior requires resources that the bill does not allocate. Finally, the statutory treatment that labels tips as “gifts” for state conformity raises legal and administrative questions about interactions with other tax provisions, deductions, and benefit eligibility formulas tied to state wage reporting.
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