Introduction

The term “No Tax on Tips” may sound like workers no longer need to pay any taxes on their tips. However, the rule is not quite that simple. This new rule contains many different conditions and restrictions. Many tipped workers may receive a federal income tax break, but tips must still be reported through payroll.

What Is No Tax on Tips?

No Tax on Tips is a temporary federal tax deduction for certain workers who receive tips. The deduction applies to tax years 2025 through 2028.

An eligible worker may be able to deduct up to $25,000 of qualified tips on a federal income tax return.

A deduction lowers the amount of income used to calculate federal income tax. It does not mean the worker automatically receives $25,000 from the government.

For example, suppose an employee earns:

• $35,000 in regular wages
• $10,000 in qualified tips

The employee still reports $45,000 of total income. However, the employee may be allowed to deduct up to $10,000 of qualified tips when calculating federal taxable income.

The actual tax savings will depend on the worker’s total income, filing status, deductions, tax credits, and other financial information.

Which Tips Qualify?

A qualified tip must generally be voluntary. This means the customer chooses whether to leave a tip and chooses the amount.

Examples of tips that may qualify include:

• Cash left by a customer
• Tips added to a credit or debit card
• Tips received through a payment app
• Tips received through a workplace tip pool
• Properly reported tips received by certain self-employed workers

Tips must be properly reported to qualify.

What Does Not Count as a Qualified Tip?

A required service charge usually does not count as a voluntary tip.

For example, a restaurant may automatically add an 18 percent service charge to the bill for a large group. The customer is required to pay that amount. Because the customer did not choose whether to pay it, the amount is generally treated as wages instead of a qualified tip.

Calling a required charge a “gratuity” does not automatically make it a tip. What matters is whether the customer had a choice.

Other fees charged by a business, such as delivery fees or event service fees, may also be treated differently from voluntary tips.

Who May Qualify?

The deduction is generally available to workers in jobs that commonly received tips before the law was passed.

Examples of workers who may qualify include:

• Restaurant servers
• Bartenders
• Baristas
• Hotel workers
• Hairstylists and barbers
• Nail technicians
• Massage therapists
• Casino dealers
• Tour guides
• Taxi and rideshare drivers
• Delivery drivers
• Valet attendants
• House cleaners
• Pet groomers
• Personal trainers

The IRS has an official list of occupations that may qualify.

Receiving an occasional tip does not automatically make someone eligible. The worker must be in a qualifying occupation, and the payment must meet the requirements of a qualified tip.

Employees and certain self-employed workers may qualify, but there are special rules that may apply to business owners and independent contractors.

What Is the Maximum Deduction?

The maximum deduction is generally $25,000 per federal tax return.

A worker cannot deduct more tips than they actually earned.

For example, an eligible employee who receives $7,500 in qualified tips may be able to deduct up to $7,500. The employee would not receive a $25,000 deduction just because that is the maximum amount allowed.

The deduction begins to decrease when a taxpayer’s income is more than:

• $150,000 for most taxpayers
• $300,000 for married couples filing jointly

Higher-income taxpayers may receive a smaller deduction or may not qualify for the deduction.

Married taxpayers generally must file a joint tax return to claim it.

Are Tips Still Subject to Payroll Taxes?

Yes.

This is one of the most important things for employees and employers to keep in mind.

Tips may still be subject to Social Security and Medicare taxes. These are often called payroll taxes or FICA taxes.

Employers should not remove tips from payroll. Employees should not stop reporting cash tips.

Federal income tax may still be withheld from an employee’s paycheck during the year. The employee may then claim the allowed tip deduction when filing a federal income tax return.

In simple terms, tips are still reported as income, but eligible workers may receive a federal income tax deduction later.

Do State Taxes Still Apply?

No Tax on Tips is a federal tax rule. Each state has its own tax laws.

Some states may follow the federal deduction. Other states may continue taxing all tip income. Local income taxes may also apply in certain cities or areas.

Workers should not assume that No Tax on Tips removes state and local taxes, and employees who live in one state and work in another may have additional tax filing requirements.

What Should Employees Do?

Employees should continue reporting their tips to their employer as required.

Workers should also keep a simple daily record of their tips. The record should include:

• The date the tips were received
• Cash tips
• Credit and debit card tips
• Tips received from a tip pool
• Tips shared with other employees
• Required service charges

Employees should review their paystubs and year-end tax forms to make sure the amounts appear correct.

Not every amount listed as a tip or gratuity will necessarily qualify for the deduction. Mandatory service charges and other required fees may be treated differently.

Employees should also be careful before changing their federal income tax withholding. Reducing withholding may increase take-home pay but reducing it too much could cause the employee to owe taxes when filing a return.

Income from a spouse, second job, investments, bonuses, or other sources can affect the final tax calculation.

What Should Employers Do?

Employers should continue following all normal payroll and tip reporting rules.

Payroll records should clearly separate:

• Regular wages
• Voluntary tips
• Tip pool payments
• Mandatory service charges
• Other employee payments

Separating these amounts is important because voluntary tips and required service charges may receive different tax treatment.

Employers should also make sure employee job titles and duties are accurate. A worker’s occupation may affect whether the tips qualify for the deduction.

Managers should not tell employees that tips no longer need to be reported. Failure to report tips correctly can create problems for both the employee and the business.

Employers should also confirm that their payroll software and year-end reporting procedures are updated for the new requirements.

Common Misunderstandings

No Tax on Tips does not mean:

• Employees can stop reporting cash tips
• Employers can leave tips out of payroll
• Every service charge is a qualified tip
• Social Security and Medicare taxes disappear
• Every worker who receives a tip qualifies
• State and local taxes automatically disappear
• Every tipped worker receives a $25,000 refund

It is a federal income tax deduction with limits and requirements, and it does not make every tip completely tax free.

Conclusion

No Tax on Tips may provide helpful federal income tax savings for eligible tipped workers. However, tips must still be properly reported.

Employees should continue reporting their tips and keeping accurate records. Employers should continue processing tips through payroll and withholding required payroll taxes. The simplest approach is to report all income correctly and then claim any available deduction when preparing the federal income tax return. If you need assistance navigating your taxes, Volpe Consulting has tax professionals who would be happy to help!

Disclaimer

This article is for general educational purposes only. It is not legal, tax, payroll, accounting, or financial advice.

Tax rules may change, and the correct treatment of tips depends on the worker’s occupation, income, filing status, location, and individual situation. Employees and employers should speak with a qualified tax, payroll, accounting, or legal professional before making decisions based on this information.