Personal income taxes: unemployment insurance: tips.

Assembly Member Castillo proposes significant changes to California's tax treatment of gratuities through legislation that would exclude tips from personal income tax and modify related employment regulations from 2026 through 2031.

The bill creates a five-year exclusion period during which tips would not be counted as gross income for state tax purposes or as wages for unemployment insurance and employment training taxes. Under the proposal, tips are defined as any gratuity provided by a customer or client of an employer's business.

To implement these changes, the legislation amends multiple sections of both the Revenue and Taxation Code and Unemployment Insurance Code. Key provisions require employees to report tips to employers through written statements by the 10th day of the following month. Employers must adjust their withholding practices and reporting systems to reflect the exclusion of tips from taxable wages.

The Franchise Tax Board would track utilization of the exclusion through tax return data and submit a report to the Legislature by December 2036 detailing the number of returns claiming the exemption. The bill's authors state their goal is to help workers retain more of their earnings.

All provisions are set to expire on January 1, 2031, unless extended by future legislation. The measure requires employers to update payroll systems and implement new reporting mechanisms while maintaining existing tip documentation requirements. State agencies would need to modify forms, instructions and compliance processes to accommodate the temporary exclusion of tips from various tax bases.

The bill specifies that tips must still be reported through written statements to employers, even though they would not be subject to state income tax during the exclusion period. This maintains transparency while providing tax relief targeted specifically at gratuity-based income.