The IRS recently released guidance on the new “no tax on tips” provision, defining qualified tips and eligible occupations, and offering some clarity for employers and workers in tipped occupations.
The proposed regulations define “qualified tips” as voluntarily paid cash tips, excluding service charges. It also offers examples to clarify what qualifies, plus provides a list of eligible occupations spanning the food service, hospitality, personal services and transportation industries.
“No tax on tips” provision background
The “no tax on tips” provision was enacted as part of the One Big Beautiful Bill Act (OBBBA) and allows individuals to exclude qualified tips from gross income for federal income tax purposes for tax years 2025 through 2028. While employers must continue withholding federal income tax, Social Security and Medicare taxes, eligible taxpayers can claim the exclusion as an above-the-line deduction on their federal returns. This deduction, retroactively effective from Jan. 1, 2025, is capped at $25,000 and gradually phased out by $100 for every $1,000 of modified adjusted gross income above $150,000, or $300,000 for joint filers. Starting with earnings in 2026, employers and other service recipients must separately report the taxpayer’s occupation and qualified tips on information statements provided to service providers.
The IRS has not released guidance on how employers will report tips for tax year 2025. The OBBBA denotes tax year 2025 as a transition year. For qualified tips reported prior to Jan. 1, 2026, employers would be permitted to approximate tips “by any reasonable method specified by the Secretary” of the Treasury, which has yet to be issued.
Eligible occupations for tax relief involving tips
The proposed regulations outline a comprehensive List of Occupations that Received Tips, identifying nearly 70 distinct roles commonly associated with tipped income. Each occupation is assigned a unique three-digit Treasury Tipped Occupation Code (TTOC), accompanied by a brief description of the services typically performed and illustrative examples of specific job titles.
- 100s: Beverage and food service
- 200s: Entertainment and events
- 300s: Hospitality and guest services
- 400s: Home services
- 500s: Personal services
- 600s: Personal appearance and wellness
- 700s: Recreation and instruction
- 800s: Transportation and delivery
These occupations range from bartenders, car wash employees, hairdressers, taxi drivers, tour guides and even water taxi operators. According to the initial draft of the 2026 Form W-2, employers will be required to report the applicable TTOC in new Box 14b, while qualified tips will be disclosed in Box 12 using code TP.
Voluntary tips requirement
The proposed regulations offer 10 illustrative examples to clarify the requirement that tips must be paid voluntarily and determined solely by the customer, without negotiation, to qualify. Several examples focus on restaurant-tipping scenarios:
- A mandatory, non-negotiable charge added to a bill’s tip line does not qualify as a tip.
- If a bill includes both an automatic charge and a separate line labeled “additional tip amount,” only the amount voluntarily entered by the customer on the latter line qualifies as a tip.
- “Recommended tip” suggestions printed on a bill—where the customer retains the option to modify or disregard the amount—are not considered service charges, and any amount paid is treated as a qualified tip.
- When a handheld point-of-sale (POS) device presents tipping options such as 15%, 18%, 20%, “other” and “no tip,” any amount selected is considered a qualified tip due to the customer’s voluntary choice. However, if the “no tip” option is absent and a minimum percentage is required, that base amount would not qualify, though any additional amount above the minimum would.
Food and beverage establishments should proactively evaluate their tipping practices considering the proposed regulations, particularly regarding mandatory service charges and POS configurations. To ensure tips qualify under the new rules, employers may need to revise bill formats or POS prompts to clearly distinguish voluntary tip amounts, such as adding language that affirms customer discretion. Additionally, businesses should prepare for the potential administrative burden of tracking and reporting tips in two categories: qualified tips and non-qualified amounts. This may require updates to payroll systems, staff training and coordination with tax advisors to ensure compliance and optimize reporting accuracy.
Adapting to the proposed rules
For middle market businesses, particularly service industries, these changes signal a shift in payroll reporting and tip-tracking requirements, prompting employers to reassess POS systems, tip-sharing arrangements and employee classifications to maintain compliance and optimize tax advantages. While transitional guidance is anticipated, early awareness and proactive preparation will be key to staying ahead.
This is just one provision within a sweeping new tax law. Partnering with a payroll provider that specializes in payroll tax administration can help ensure your business remains compliant, plus we bring additional expertise through our relationship with the restaurant tax pros at Doeren Mayhew. Contact us today to learn more.