No Tax on Tips: Tax Exemption on Tips 2025 Updates

Congress recently passed a budget reconciliation bill known as the “One, Big, Beautiful Bill.” This bill contains a number of significant provisions, one of them being a law eliminating taxes on tips.

Read on to learn more about the taxation of tips and how businesses and employees may be impacted.

What are tips and how are they currently taxed?

According to the current IRS definition, “Tips are optional cash or non-cash payments that customers make to employees.” Cash tips include those received directly from customers as cash, but also electronically paid tips and any tips received as part of a tip-sharing arrangement.

Non-cash tips are those received in any medium other than cash, such as tickets, passes or other goods a customer gives the employee.

To determine whether a payment is a tip, the IRS uses a four-factor standard in which all four factors must apply:

• The customer makes the payment free from compulsion.
• The customer has an unrestricted right to choose the amount.
• The payment should not be the subject of negotiations or dictated by employer policy.
• Generally, the customer has the right to determine who receives the payment.

What is the “No Tax on Tips” provision?

“No Tax on Tips” within the One, Big, Beautiful Bill creates an above-the-line deduction on the taxpayer’s tax return for qualified tips received by workers in an occupation which traditionally and customarily receives tips. In order to be considered a qualified tip, the tip amount must be paid voluntarily, is not subject to negotiation and is determined by the payor, not the business or the employee. The deduction is allowed for employees receiving a W-2, independent contractors receiving a 1099-K or 1099-NEC, and taxpayers reporting tips on Form 4137.

The One, Big, Beautiful Bill caps the total deduction that can be claimed at $25,000 and slowly phases out the deduction for individuals earning over $150,000 ($300,0000 for joint returns).

A work-eligible Social Security number is required in order to claim the deduction. The deduction is allowed from tax years 2025 through 2028.

The deduction does not eliminate payroll taxes for Social Security and Medicare, nor does it affect state or local tax obligations.

When will the “No Tax on Tips” law take effect?

The One, Big, Beautiful Bill became law on July 4, 2025, and it applies to taxable years beginning after Dec. 31, 2024. It is retroactive to Jan. 1, 2025.

The deduction is allowed for tax years 2025 through 2028.

States considering tip tax exemptions

The legislation has no effect on state and local rules dealing with tips or overtime. Because each locale has its own laws, it’s important for each employer to understand how they interact with federal legislation.

Who benefits from tax-free tips?

After the July Fourth passage of the One, Big, Beautiful Bill, the Treasury Department has 90 days to publish a list of occupations it determines to have traditionally and customarily received tips (based on pre-2024 data). This official list is intended to ensure this benefit goes to workers like waiters or baristas, not corporate executives.

The hospitality industry will likely feel the biggest impact, as a high percentage of hospitality employees receive most of their earnings in tips. This may also take some steam out of efforts to reduce state-level tip credits and initiatives championed by some employers to do away with tipping altogether in favor of service charges or higher prices.

What do tax-free tips mean for employers?

This provision in the One, Big, Beautiful Bill may have a significant impact on employees, there will also be consequences for employers. That standalone Senate bill will impact employers where applicable.

This is how it’s projected to impact employers.

Tips will still be reported — Employees must report their tips to their employer, and employers will still have to report tips on the employee’s W-2.

Taxes on tips will still be withheld — Because of the way this provision functions, taxes on tips will be withheld, then subtracted from the total tax liability when eligible employees file their annual returns. This means tips are still subject to federal income tax withholding.

Form W-2 reporting likely won’t change very much — Under this provision, employers will need to separately identify total tips reported by employees when they produce the employee’s Form W-2.

Be aware of what aren’t considered tips — Service charges, like 18% gratuities automatically placed on large parties at restaurants, are not tips. Tips that are not reported to the employer may still be deductible if employees use a Form 4137 to report them.

Accounting systems may need to be adjusted — Not every business has a mechanism for specifically recording or tracking income from tips. You may need to reconfigure your system to provide the necessary information to your workforce and appropriate regulators.

There are also staffing forces to consider. With this tax benefit also comes the possibility of an environment where it’s easier to recruit and solve labor shortages in the hospitality industry.

In states that permit it, back-of-house workers like cooks or dishwashers who participate in a tip pool can also benefit. But that isn’t the case in every state. In other states, it may widen the asserted unfairness between servers and back-of-house staff regarding compensation. Hospitality employers may need to review their compensation practices as the favorable tax treatment for tips has the potential to increase the divide between the earnings of tipped and non-tipped workers.

Staying compliant with the new tips tax exemption rules

Employers will need to track and report tips as a separate category so these figures can be given to employees for their year-end tax filing.

Frequently asked questions

Are tips currently taxed at the same rate as wages?

For federal purposes, tips are generally treated in the same way as other taxable wages.

What is the tax rate for tips?

The tax rate for tips is the same as other regular earnings.

Will this new rule apply to all industries that accept tips?

Yes, as long as the employee in question is participating in one of the occupations that will be determined by the Treasury Department to be one that customarily receives tips.

Will tips still need to be reported on tax returns?

Yes. Employees will need to report their tips to their employer, and employers will be required to report an employee’s tips on the W-2.

How will the No Tax on Tips provision affect my tax refund or liability?

The provision reduces your tax liability by an amount equal to the reported tips.

Will cash and credit card tips be treated differently?

No, cash and credit card tips are considered the same under this legislation.

Is the tip tax exemption permanent or temporary?

It applies for tax years 2025-2028. Unless Congress acts, the exemption will expire for 2029.

Are service charges considered tips under this law?

Service charges, like an 18% gratuity on a large party at a restaurant, are not considered tips.

How should I track and report my tips going forward?

As necessary, tips should still be reported by employees to their employers. Employers will report recorded tips to their employees via Form W-2, Wage and Tax Statement.

Does this affect state income tax on tips?

The provision has no impact on how states tax tips.

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