Restaurants, hotels, salons, and other service businesses face unique tax responsibilities when employees receive tips. Recent federal tax changes offer potential savings for eligible workers and certain employers, but accurate reporting remains essential.
The “No Tax on Tips” provision allows eligible individuals to deduct qualified tips for federal income tax purposes. It does not eliminate tip reporting requirements or Social Security and Medicare taxes.
Here is what employers and tipped workers should know when planning for 2026.
What Is the No Tax on Tips Deduction?
The One Big Beautiful Bill Act, signed into law July 4, 2025, created a deduction for qualified tips for tax years 2025 through 2028.
Eligible employees and self-employed individuals can claim the deduction whether they take the standard deduction or itemize.
Deduction Limits and Eligibility
The deduction is subject to several requirements:
- Annual limit: Up to $25,000 per tax return, including a joint return.
- Income limits: The deduction begins phasing out when modified adjusted gross income exceeds $150,000, or $300,000 for married couples filing jointly.
- Filing status: Married taxpayers must file jointly.
- Identification: The person whose tips support the deduction must have a qualifying Social Security number.
- Occupation: Tips must be earned in an occupation on the IRS list of qualifying tipped occupations.
- Self-employment limit: The deduction cannot exceed net income, calculated before this deduction, from the business where the tips were earned.
The $25,000 limit is a deduction from income, not a $25,000 tax credit or guaranteed refund. Actual savings depend on the taxpayer’s circumstances.
What Changed Under the 2026 IRS Rules?
In April 2026, Treasury and the IRS finalized regulations defining qualified tips and identifying more than 70 qualifying occupations.
The final list includes traditional tipped roles and other service occupations. It also added visual artists, floral designers, and gas pump attendants.
Employers and workers should review the IRS list of qualifying tipped occupations rather than assume that every job receiving tips qualifies.
What Counts as a Qualified Tip?
Qualified tips generally must be voluntary, determined by the customer, and paid in cash or a qualifying cash equivalent. Examples include credit card, debit card, check, and cash-denominated mobile payments.
Employees may also receive qualified tips through voluntary or mandatory tip-sharing arrangements, provided the other requirements are met.
Mandatory Service Charges Are Different
An automatic charge that customers cannot remove or change generally does not qualify.
For example, an automatic 18% service charge added to a restaurant bill is not a qualified tip if the customer has no option to disregard or modify it. Amounts distributed to employees from that charge are treated as wages.
Noncash items, such as event tickets or meals, also do not qualify for the deduction. Review the IRS explanation of the final tip regulations for additional details.
Some Eligibility Rules Have Transition Relief
The law excludes tips received in a specified service trade or business, a tax classification covering certain professional and service activities.
However, IRS guidance provides temporary relief from that restriction for workers in qualifying tipped occupations. The April 2026 final regulations did not resolve this issue or end that relief. Its end date depends on separate final regulations addressing the restriction and associated reporting.
Businesses with questions about this classification should review IRS Notice 2025-69 with their tax advisor.
Do Employers Still Withhold Taxes on Tips?
Yes. The deduction does not automatically make tips exempt from payroll withholding.
Reported tips generally remain subject to federal income tax withholding and applicable Social Security and Medicare taxes. Employers must continue paying their share of Social Security and Medicare taxes.
Eligible employees claim the deduction on their federal income tax return. Employees considering withholding adjustments should use the current Form W-4 instructions and account for their overall tax situation.
What Are the New Employer Reporting Requirements for 2026?
For tax year 2026, Form W-2 includes additional tip reporting information:
- Box 12, code TP: Total cash tips reported to the employer.
- Box 14b: Applicable Treasury Tipped Occupation Code or codes.
These entries supplement existing wage and tip reporting. Code TP does not, by itself, establish that every reported dollar qualifies for the employee’s deduction.
Businesses paying independent contractors must also review the applicable separate tip reporting and occupation-code requirements for Forms 1099-NEC, 1099-MISC, and 1099-K.
The IRS provided transition relief for 2025 reporting. Employers should prepare their payroll systems for the 2026 requirements using the 2026 Form W-2 instructions.
How Should Employees Track and Report Tips?
Good records help employees report income correctly and support any qualified tips deduction.
Keep Daily Tip Records
Employees should track cash tips, charged tips, tips received through sharing arrangements, and amounts paid to other employees. They should separately document noncash tips.
Report Tips to the Employer Each Month
Employees who receive $20 or more in cash tips during a calendar month from one employer must generally report those tips to that employer by the 10th of the following month.
Cash tips include charged tips and tips received through sharing arrangements. Tips below the monthly reporting threshold and noncash tips must still be included on the employee’s federal income tax return.
Claim the Deduction on the Tax Return
Eligible taxpayers claim the deduction using Schedule 1-A with Form 1040. Applicable reporting requirements must be met; the deduction does not permit workers to leave tips off their returns.
Workers who already filed a 2025 return may need to consider an amended return if the final occupation list changes their eligibility. The IRS explains this option in its guidance on amending a return to claim the tips deduction.
What Tax Benefits Are Available to Employers?
The employee deduction is separate from tax credits and deductions available to the business.
Expanded FICA Tip Credit
Eligible food and beverage businesses may qualify for the Section 45B FICA tip credit for certain employer Social Security and Medicare taxes paid on employee tips.
The 2025 law expanded this credit to qualifying businesses providing:
- Barbering and hair care.
- Nail care.
- Esthetics.
- Body and spa treatments.
The credit has specific calculation rules and does not automatically cover all employer payroll taxes. Employers claim it using Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips.
Increased Section 179 Deduction
For tax years beginning in 2026, the maximum Section 179 deduction is $2,560,000. That limit is reduced when qualifying property placed in service exceeds $4,090,000.
Section 179 may allow businesses to deduct eligible equipment costs sooner. Business-income limits, qualifying-property requirements, and special vehicle restrictions still apply.
Restored 100% Bonus Depreciation
The 2025 law restored 100% bonus depreciation for qualifying property acquired and placed in service after January 19, 2025.
Eligible purchases may include certain equipment, machinery, and other business assets. Acquisition dates, business use, and property classifications affect eligibility.
Review IRS Publication 946 and work with your tax advisor to compare Section 179, bonus depreciation, and regular depreciation.
How Can Employers Prepare?
Businesses with tipped workers should:
- Confirm that payroll systems capture cash tips and occupation codes.
- Separate voluntary tips from mandatory service charges.
- Explain employee reporting requirements clearly.
- Review eligibility for the expanded FICA tip credit.
- Evaluate equipment deductions before year-end purchases.
THF’s Business Tax Services can help businesses assess available tax benefits and plan for reporting obligations.
Make Your Next Tax Planning Move With THF
New tip-income rules can create opportunities for workers and employers, but the benefits depend on accurate records and proper reporting.
Contact THF to review your tip reporting procedures, evaluate available credits and deductions, and prepare your business for the updated tax rules.
