The IRS recently released proposed regulations that clarify which types of tips qualify under the new No Tax on Tips provision of the One Big Beautiful Bill Act. This guidance is essential for both employees and employers in industries where tips are a standard part of compensation. While the rules are not yet final, they clearly show how the IRS expects businesses and workers to handle tip income beginning in 2025.
What the No Tax on Tips Provision Covers
The law allows certain workers in tip-based occupations to claim a deduction on tip income for tax years 2025 through 2028. The maximum deduction is $25,000 per year, with phaseouts beginning at $150,000 in modified adjusted gross income for single filers and $300,000 for joint filers. To benefit, the tips must be considered qualified under the IRS definition.
Occupations That Customarily Receive Tips
The proposed regulation includes a list of occupations that the IRS determined regularly received tips as of December 31, 2024. These occupations cover areas such as food and beverage service, hospitality, personal care, transportation, entertainment, recreation, and wellness. If a worker’s job falls into one of these categories, their tips may qualify for the deduction, subject to the rules explained below. Employers will eventually need to code occupations correctly on payroll and reporting forms once the IRS finalizes the process.
The IRS Definition of Qualified Tips
For tips to be considered qualified under the new deduction, they must meet several conditions:
- Tips must be voluntary payments. The amount must be determined by the customer and not subject to negotiation.
- Tips can be paid in cash, credit card, debit card, check, gift card, or through other electronic settlement systems. Tokens or vouchers readily exchangeable for cash also qualify.
- Tips may come through tip sharing or pooling arrangements if those systems meet IRS standards.
- Service charges and mandatory gratuities are excluded, unless the customer had the option to modify or decline them.
- Tips from illegal activities, such as prostitution or gambling operations, are not eligible.
- Tips received in specified service trades or businesses, such as accounting, financial services, or consulting, do not qualify.
Understanding these criteria will be essential for both employees and employers to ensure accurate reporting and to avoid unexpected issues during tax filing.
Dual Jobs and Mixed Duties
One area of complexity involves workers with dual roles. For example, a restaurant employee may work as both a server and a dishwasher. In this case, only the income from the tipped occupation would qualify. Employers will need to maintain accurate records to separate tipped and non-tipped duties to comply with IRS requirements.
Reporting Requirements
The IRS is developing changes to reporting forms to account for qualified tips. Employers will need to provide detailed information on W-2s and potentially include occupation codes. In some cases, Forms 1099-NEC, 1099-MISC, or 1099-K may apply. Employees who do not report all tips to their employer will still be responsible for reporting them using Form 4137.
Why This Matters for Your Business
The proposed rules will affect payroll systems, recordkeeping, and employee communication. Employers will need to:
- Train managers and payroll staff on the definition of qualified tips
- Ensure systems track tips separately from service charges
- Code occupations properly in payroll records once guidance is finalized
- Communicate clearly with employees about what will qualify and how reporting will change
For employees, the key will be to keep thorough records of tips, verify that employers are tracking them correctly, and work with tax preparers to maximize the deduction within the income limits.
What To Know In 2025
The rules are still in the proposal stage, and the IRS has invited comments through October 23, 2025. Final regulations may adjust some definitions or reporting requirements. Businesses should not wait, however, to begin evaluating how these rules will apply. Reviewing payroll systems, clarifying policies around service charges, and preparing employees for the change will make the transition smoother once the rules are finalized.
How CPA Nerds Can Help
Our team is monitoring this regulation closely and will update you as final rules are released. We can assist with evaluating your payroll practices, advising on recordkeeping, and ensuring your employees are positioned to benefit from the deduction. Contact us if you would like a review of your systems or guidance on preparing for the 2025 transition.
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