Background: The “No tax on tips” provision in the OBBBA
The “No tax on tips” provision in the OBBBA signed into law on July 4, 2025, added a new section to the Internal Revenue Code (the Code) that provides for an income tax deduction for “qualified tips” received by taxpayers performing services in an occupation that customarily and regularly received tips on or before Dec. 31, 2024.
The deduction is capped at $25,000 and is subject to a phaseout of $100 for each $1,000 by which the taxpayer’s modified adjusted gross income (MAGI) exceeds $150,000 for single filers ($300,000 for joint filers). The “No tax on tips” deduction is effective retroactively to Jan. 1, 2025, and applies to tax years 2025–2028.
The IRS previously announced that it will not make changes to 2025 information reporting or withholding tables related to the new law. Form W-2, existing Forms 1099, and Form 941 and other payroll return forms will remain unchanged for tax year 2025. Federal income tax withholding tables will not be updated for tax year 2025.
As a result, employers and payroll providers should continue using current procedures for reporting and withholding. The IRS also indicated that transitional guidance will be provided with respect to identifying and reporting qualified tips and claiming the deduction for 2025.
Beginning with amounts earned in 2026, employers (or other service recipients, as required) are required to identify the occupation of the taxpayer and qualified tips separately on information statements furnished to a service provider. Qualified tips are defined as cash tips received by an individual in an occupation that customarily and regularly received tips on or before Dec. 31, 2024. Qualified tips do not include any amount received by an individual unless the amount meets all of the following criteria:
- Is paid voluntarily without any consequence in the event of nonpayment, is not subject to negotiation, and is determined by the payor
- Is not received in the course of a trade or business that is a specified service trade or business as defined in section 199A(d)(2) of the Code (generally accounting, consulting, performing arts, athletics, financial services, brokerage health, law and other professional service firms)
- Satisfies such other requirements as may be established by the Secretary of the U.S. Department of the Treasury in regulations or other guidance.
Defining eligible occupations and qualified tips—and other proposed rules
Occupations that may be eligible for tax relief involving tips
The proposed regulations clarify the application of certain rules in the Code and certain terms.
Only qualified tips received in occupations that customarily and regularly received tips on or before Dec. 31, 2024, are eligible to be deducted from income. The proposed regulations include a list of such occupations, referred to as the List of Occupations that Received Tips. The specific occupations in the list are each assigned a three-digit code called a Treasury Tipped Occupation Code (TTOC). The TTOC would be grouped together in the following occupational categories:
- 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
A brief description of the types of services performed by individuals working in each occupation code is included along with illustrative examples of specific occupations. Nearly 70 separate occupations of tipped workers—from bartenders, car wash employees, hairdressers, taxi drivers, tour guides and even water taxi operatorsare included on the list.
An initial release of the draft 2026 Form W-2 indicates that employers will have to report the TTOC in new Box 14b along with the amount of qualified tips reported in Box 12 with code TP.
Definition of qualified tips
The proposed regulations would define qualified tips as cash tips. They would include tips received from customers or, in the case of an employee, through a mandatory or voluntary tip-sharing arrangement, such as a tip pool, that are paid in cash, check, credit card, debit card, gift card, tangible or intangible tokens that are readily exchangeable for a fixed amount in cash (such as casino chips), and any other form of electronic settlement or mobile payment application that is denominated in cash.
Qualified tips would not include items paid in any medium other than cash or charge—such as event tickets, meals, services, or other assets that are not exchangeable for a fixed amount in fiat cash (e.g., digital currency or digital assets).
Qualified tips would include amounts paid by customers for services that are in excess of the amount agreed to, required, charged, or otherwise reasonably expected to have to be paid for the services in an arm’s length transaction.
Additionally, service charges automatic gratuities (such as a mandatory “tip” for seating a large group in a restaurant), and other mandatory amounts automatically added to a customer’s bill by the vendor or establishment, are not qualified tips unless the customer is expressly provided an option to disregard or modify it without consequence.
Qualified tips would include tips reported pursuant to an agreement under the Tip Rate Determination Agreement (TRDA) program or a Model Gaming Employee Tip Reporting Agreement as part of the Gaming Industry Tip Compliance Agreement (GITCA) program provided that the participating employee in the TRDA or GITCA program is otherwise eligible for the deduction and reports tips using the tip rates established under their respective agreement. The proposed regulations would also clarify that an employee participating in the TRDA or GITCA program may report additional qualified tips to the IRS on the Form 4137 (Social Security and Medicare Tax on Unreported Tip Income).
Amounts received for services the performance of which is a felony or misdemeanor under applicable law would not be qualified tips. The regulations note working as a bartender without a required license would fit in this category. In addition, the proposed regulations would provide that amounts received for prostitution services and pornographic activity are not qualified tips.
Finally, to prevent reclassification of income as qualified tips, and to prevent abuse of the deduction, the proposed regulations would also provide that a payment is not a qualified tip if the tip recipient has an ownership interest in or is employed by the payor of the tip.
Requirement that tips be voluntary
The proposed regulations include 10 examples to illustrate application of the requirement that tips must be paid voluntarily and determined by the payor without negotiation in order to qualify. The examples related to restaurant tipping illustrate that:
- non-negotiable automatic charge added to a bill’s tip line would not be a qualified tip.
- If an automatic charge is added to a bill’s tip line but there is also a line for “additional tip amount,” the automatic charge would not be a qualified tip, but an amount added to the “additional tip amount” line by a customer would be a qualified tip.
- “Recommended tip” guidelines added to a bill with the option that a customer may disregard or modify the amount is not a service charge and the actual tipped amount is a qualified tip.
- If a handheld point of sale device (POS) prompts a customer to leave a tip and provides the following options: 15%, 18%, 20%, “other”, and “no tip”, then an amount tipped would be a qualified tip since the customer voluntarily chooses to leave the tip. If the “no tip” option is not available, then the minimum percentage the customer is required to tip would not be a qualified tip but any amount in excess of that minimum percentage would be a qualified tip.
Adapting to the proposed rules: Food and beverage establishments may want to reconsider mandatory service charge policies or POS options for tipping, including whether it is appropriate to add sufficient language to bills or on the POS that would allow the total tip amount to meet the requirements to be qualified tips. There may be a significant administrative burden on employers changing policies or establishing capabilities to bifurcate tips into qualified tips and other for reporting purposes.
Qualified tip rules related to a specified service trade or business
Qualified tips do not include those received by a person performing services in a specified service trade or business (SSTB). An SSTB is defined under the Code for purposes of a separate business deduction and is cross-referenced for “No tax on tips.”
An SSTB is any trade or business either involves the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners; or it involves the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities.
The proposed regulations would provide that an amount received by an individual in an SSTB is not a qualified tip, including those received by an employee performing services for their employer in a SSTB.
If the individual performs services as an employee, the relevant trade or business is the trade or business of the employer in which the employee is performing services. Thus, an amount received by an employee performing services for their employer in a SSTB is not a qualified tip regardless of whether the employee is performing services in an occupation included in the list or whether that occupation is a SSTB. The proposed regulations provide the following examples:
- A pianist is an employee of a hotel that is not a SSTB. The pianist plays the piano in the lobby of the hotel and patrons leave cash tips. The cash tips are qualified tips even though the tips are received for services in the performing arts, which is a SSTB, because the pianist is performing services as an employee of the hotel, which is not a SSTB, and the pianist’s occupation (piano player) is included in the TTOC category of “Musicians and singers.”
- A bartender is an employee of a business that is not a SSTB. A theater contracts with the bartender’s employer to provide bartending services during the intermission of certain live performances. The bartender receives cash tips from patrons. The cash tips are qualified tips because the bartender is performing services as an employee for a business that is not engaged in a SSTB, and the bartender’s occupation is included in the TTOC category of “Bartenders.”
The preamble to the proposed regulations notes that for SSTBs, the meaning of “performing services” in the performing arts means “the performance of services by individuals who participate in the creation of performing arts, such as actors, singers, musicians, entertainers, directors, and similar professionals performing services in their capacity as such.”
However, the regulations provide that services for an SSTB company in a job that does not require skills unique to the creation of performing arts, such as an usher who is an employee of a theater are not covered under the SSTB rules.
The proposed regulations provide that an amount received by an individual performing services in the course of a SSTB is not a qualified tip. The Treasury Department and the IRS request comments on how these rules should apply for purposes of qualified tips.
Other clarifications
- The regulations also clarify certain other statutory rules, including the requirement to include Social Security wage information on the tax return for the year in which the deduction is claimed and that $25,000 is the deduction limitation for tips regardless of filing status (single-filer or joint filer).
- The IRS is expected to issue transitional relief for employers and taxpayers to determine and deduct, respectively, qualified tips for tax year 2025. It is yet to be determined whether employers or other service recipients will have to implement a reporting system to separate qualified tipped income from other forms of reportable income.
- These proposed regulations do not address the “No tax on overtime” provision in the OBBBA. Similar to the “No tax on tips” provision, the OBBBA provides an income tax deduction for qualified overtime pay received by certain employees (the statute refers to the Fair Labor Standards Act (FLSA)). The qualified overtime deduction is capped at $12,500 ($25,000 for joint filers) and is subject to a phase out of $100 for each $1,000 by which the taxpayer’s MAGI exceeds $150,000 for single filers ($300,000 for joint filers). The “No tax on overtime” deduction is effective retroactively to Jan. 1, 2025, and applies to tax years 2025–2028.
While the OBBBA directed Treasury and IRS to issue regulations or other guidance with respect to the no tax on overtime provision, publication of that guidance may require coordination with the U.S. Department of Labor, which may impact the publication timeline.
New draft IRS forms
The IRS recently released draft versions of several forms that will be key to implementing the qualified overtime deduction for tax years 2025 through 2028. Note that the draft forms remain preliminary and are subject to change until the IRS issues final versions.
- 2025 Deductions Worksheet: Taxpayers can use this worksheet to account for the qualified tips and overtime deductions in the income tax withheld from the remainder of 2025 paychecks. If using this worksheet, an employee would submit a new 2025 Form W-4 to the employer.
- The IRS’s Tax Withholding Estimator online tool has not been updated to reflect these deductions.
- A new form, draft Schedule 1-A, has been introduced for tax year 2025 for taxpayers to calculate their deductions for qualified tips and qualified overtime as an adjustment to their AGI when filing their Form 1040.
- The IRS also released a draft Form W-4 and accompanying worksheets for 2026. The updated Deductions Worksheet enables employees to estimate the amount of qualified overtime and qualified tips they will receive and adjust their annual federal income tax withholding accordingly using the existing Line 4b.
- The draft 2026 Form W-2 introduces a number of changes related to the new tax deductions. The existing Box 14 has been relabeled as Box 14a; a new Box 14b appears for the TTOC. The Form W-2 instructions were also updated to require employers to include qualified overtime and qualified tips in Box 12 using new codes TT and TP, respectively.
The takeaway: Adapting to proposed rules about the “No tax on tips” provision
Middle market businesses—especially in hospitality, food service and personal services—should begin evaluating their tipping policies, payroll systems and reporting processes now. Early preparation will be key to maximizing the deduction and avoiding compliance challenges once the rules take effect.
Employers need to review these proposed regulations for application to their tip arrangements and to continue watching for additional guidance to answer questions that this guidance does not address.
