Minnesota No Tax on Tips, Overtime

A pair of bills introduced in the Minnesota House—HF 3954 (overtime) and HF 3955 (tips)—would further erode the state’s taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. climate by exempting certain overtime pay and tip income from Minnesota’s income tax. While politically popular, these measures mirror federal deductions and introduce inefficiency and non-neutrality into the tax code.

Proponents argue that the exemptions would provide targeted relief to workers in lower-paying or physically demanding jobs. Certain employees (servers, bartenders, delivery drivers, etc.) often rely on tips to supplement subminimum base wages, while hourly workers in nursing, manufacturing, and emergency services depend on overtime shifts. Supporters of such measures point to examples, like Alabama’s temporary overtime exemption, which reportedly boosted worker availability and helped ease labor shortages.

However, these targeted carveouts create significant problems. They violate horizontal equity, distort labor markets, generate large revenue losses, and come with built-in limitations that reduce the number of workers that would benefit from the provisions.

The Proposals Are Inequitable, Expensive, and Poorly Targeted

First, the proposals create horizontal inequity by treating workers with identical total earnings differently based solely on the form of compensation. Consider two individuals, each earning $30,000 annually. A secretary whose entire income comes from regular wages would pay tax on the full amount. A waiter earning $20,000 in base wages and $10,000 in tips would see the tips portion subtracted (subject to the bill’s limits), resulting in a lower tax bill. Similar disparities arise between a hotel clerk earning part of her income through overtime versus one earning the same total through standard hours, or a worker receiving a bonus versus a straight salary. These arbitrary distinctions favor specific work arrangements without principled justification. They particularly disadvantage workers—such as parents with caregiving responsibilities or those on fixed schedules—who cannot access tipped or overtime opportunities.

Importantly, the exemptions are not unlimited. Under both bills, the Minnesota subtraction matches the federal limits: a maximum of $12,500 for single filers (or $25,000 for married filing jointly) per year. The benefit phases out for higher earners—beginning at $150,000 Minnesota adjusted gross incomeFor individuals, gross income is the total of all income received from any source before taxes or deductions. It includes wages, salaries, tips, interest, dividends, capital gains, rental income, alimony, pensions, and other forms of income.
For businesses, gross income (or gross profit) is the sum of total receipts or sales minus the cost of goods sold (COGS)—the direct costs of producing goods (MAGI) for singles ($300,000 for joint filers) and is fully eliminated at $275,000–$400,000 for singles or $550,000 for joint filers, depending on the provision. This caps the benefit (and the associated revenue costs) for upper-middle and high-income workers but does not eliminate the core horizontal inequity for those who do qualify.

Second, the exemptions warp economic incentives for businesses, workers, and lawmakers. By shielding portions of tip and overtime income from taxation (up to the caps), the policy reduces pressure on employers to raise base wages, effectively subsidizing compensation through the tax code. This can accelerate tipping fatigue into new sectors and encourage businesses to rely on extra hours or bonuses rather than hiring additional workers—limiting job creation while promoting overwork. High-earning professionals may still attempt to recharacterize income to maximize the preference within the limits, creating enforcement challenges and potential revenue leakage. These narrow carveouts also risk crowding out simpler, broader tax relief, as lawmakers pursue politically attractive measures at the expense of long-term tax system integrity.

Third, the revenue losses are substantial while the benefits remain narrowly targeted. Minnesota Department of Revenue estimates project that the overtime and tip subtractions would reduce General Fund revenue by approximately $366 million and $126 million, respectively, in FY 2027—totaling nearly $492 million in the first full year. Alabama’s overtime exemption far exceeded initial projections, and Montana’s repeal of its tip exemption highlighted the difficult trade-offs involved. Forgone forecasted revenue may lead to cuts in core services or require other tax increases. At the same time, the relief reaches only a small share of workers: tipped occupations represent roughly 2.5 percent of the workforce, and while a large share of the labor force qualifies for overtime, not everyone is allowed to avail themselves of it. Broad-based reductions in marginal income tax rates would deliver more equitable relief without these complications.

In addition to the exemptions, the bills expand the Minnesota child tax credit (to $2,000 per qualifying child) and provide a one-time 11.9 percent increase in property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. refunds, indicating even more costs to be incurred by the state if these bills are passed.

The Proposed Pay-Fors Would Make Matters Worse

The revenue offsets in HF 3954 and HF 3955 compound the problems associated with the bills. To help cover these costs, they add a new fifth tax bracket at 11.45 percent on income above $600,000 (single) or $1,000,000 (joint). This would push Minnesota’s top marginal rate well above most states, making it one of the highest in the nation and directly hitting many small businesses structured as pass-through entities.

Raising progressivity in this way reduces the after-tax return on highly productive work and increases the deadweight loss of the tax system. Mobile high-income individuals and businesses can respond by relocating, gradually eroding the state’s tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. and economic opportunities for everyone. States pursuing uncompetitive tax policies relative to their neighbors often discover that revenue shortfalls materialize faster than anticipated.

Minnesota should reject these flawed bills. Layering new distortions and a punitive top rate atop an already complex system is unsound tax policy. Instead, policymakers should pursue broad-based reform that lowers marginal rates, broadens the base, and treats all income more neutrally. Sound tax policy raises the revenue needed for the state to function, but still rewards work and investment without arbitrarily picking winners based on how compensation is labeled. By prioritizing simplicity, competitiveness, and neutrality, Minnesota can deliver genuine, sustainable relief to workers while strengthening its long-term economic outlook.