Overview
The One Big Beautiful Bill (OBBB), enacted July 4, 2025, introduces a highly publicized provision exempting certain tips from federal income tax. Framed as relief for service-industry workers, the measure in practice functions as a deduction for “qualified tips” received in occupations the Treasury identifies as customarily and regularly tipped.
Core Features of the Deduction
Eligible Occupations Under the “No Tax on Tips” Provision
The Treasury and IRS guidance identifies a broad range of tipped roles across industries such as:
- Food and Beverage Services (servers, bartenders, baristas)
- Hospitality and Guest Services (valets, bellhops, concierges)
- Personal and Appearance Care (hairstylists, barbers, massage therapists)
- Entertainment and Events (casino dealers, banquet staff)
- Transportation and Delivery (rideshare drivers, couriers)
- Home and Property Services (cleaners, landscapers, pet groomers)
Amount and Limits
- Maximum deduction: $25,000 per year, phased out for taxpayers with income above $150,000 (single) or $300,000 (joint).
- The deduction is above-the-line, available even to those who do not itemize.
Qualified Tips
- Must be voluntary and not part of a mandatory service charge.
- May include cash, credit/debit card and digital payments.
- Tips from tip-sharing or pooling may qualify if properly documented.
Employer Compliance Obligations
Employers must now distinguish between taxable and non-taxable tip income, requiring updates to payroll systems and reporting protocols to reflect the new federal exemption. Employers will also need to proactively document tip sources and classifications to ensure compliance with IRS definitions and avoid audit risk.
Best Practices
- Identify and Report Eligible Occupations and Tip Income: Accurately designate qualifying occupations and report tip income on Forms W-2 or 1099, consistent with IRS guidance.
- Continue Payroll Tax Withholding: The exemption applies solely to federal income tax; FICA and Medicare withholding obligations remain unchanged
- Review Job Classifications and Tip Policies: Conduct a comprehensive review of job descriptions and tipping practices to confirm they align with IRS definitions of occupations that “customarily and regularly” receive tips.
- Maintain Substantiating Records: Retain detailed records of tip pooling, allocation and employee declarations to substantiate reported amounts in the event of an audit or regulatory inquiry
Unresolved Issues and Compliance Risks
Issues remain regarding how the “No Tax on Tips” rule will be applied in practice. The distinction between voluntary and mandatory tipping continues to create uncertainty, particularly in businesses that use service-fee or “suggested gratuity” models, where it is unclear whether payments qualify as true discretionary tips. In addition, state tax systems and payroll reporting requirements may not immediately align with the new federal exemption, creating potential inconsistencies in withholding and compliance. Finally, improper classification of workers or inadequate recordkeeping could expose employers to audit risk, resulting in disallowance of the deduction or potential penalties.
Practical Takeaways
The “No Tax on Tips” rule introduces new complexity for employers and practitioners. Compliance will hinge on accurate classification, documentation and adherence to IRS reporting standards.
Businesses should review their tip practices now, update payroll systems and prepare to adjust once final regulations are issued later this year.
Contact
To understand your risk of non-compliance and support becoming compliant with IRS tax obligations, please contact any member of KJK’s Labor & Employment Practice Group at 216.696.8700.