The IRS has released proposed regulations on the new “No Tax on Tips” provision of the One Big Beautiful Bill Act (OBBBA), which was enacted in July. These new rules provide important definitions and guidance for employers and employees regarding the tax deduction for qualified tips. While the regulations are currently in proposed form, employers can rely on them until the final regulations are published.
Key Provisions of the Proposed Regulations
The IRS’s new regulations aim to provide clarity for both employers and employees. Here are some of the key takeaways:
- Definition of Qualified Tips. A qualified tip is a cash or charged tip voluntarily given by a customer. This includes tips suggested on a bill, those allocated through a tip pool, or those paid via debit/credit cards or mobile payment apps. However, tips do not include mandatory service charges or tips suggested on a point-of-sale device with no option for “no tip,” as these are not freely given.
- Impact on Back-of-House Restaurant Workers. The proposed regulations address a key ambiguity regarding the tip credit under the Fair Labor Standards Act (FLSA). While employers cannot use a tip credit for back-of-restaurant workers (such as cooks or dishwashers) who participate in tip pools, the new regulations will allow these employees to deduct their qualified tips. Employers will be required to report these tips on the employees’ W-2 forms.
- New Occupation Categorization. The regulations introduce a new system of occupation codes to identify which jobs qualify for the deduction. These occupations are those that “customarily and regularly” received tips on or before December 31, 2024. The occupations are grouped into eight categories, including:
- Beverage and Food Service (100s)
- Entertainment and Events (200s)
- Hospitality and Guest Services (300s)
- Home Services (400s)
- Personal Services (500s)
- Personal Appearance and Wellness (600s)
- Recreation and Instruction (700s)
- Transportation and Delivery (800s)
- Tax Withholding and Reporting. While the new deduction is effective starting January 1, 2025, the IRS has confirmed there will be no immediate changes to Form W-2, Form 941, or federal income tax withholding tables for the 2025 tax year. This means that federal income tax withholding, Social Security, and Medicare taxes will still be applied to all tips. Employees will receive the benefit of the deduction when they file their 2025 tax returns in 2026. The IRS is, however, preparing new guidance and updated forms for the 2026 tax year to better align with the new reporting requirements.
Next Steps for Employers
With these proposed changes on the horizon, employers should take proactive steps to ensure compliance and prepare for the new reporting landscape.
Stay Informed: Monitor official guidance from the IRS and Treasury Department, as more details on the final regulations and reporting requirements for 2026 are expected.
Review and Update Payroll Systems: Assess your current payroll and reporting systems to ensure they can separately track and report qualified tips for all employees, including those in back-of-restaurant roles.
Communicate with Employees: Educate your employees about the new deduction, what constitutes a “qualified tip,” and the fact that tax withholding will remain unchanged for the 2025 tax year. Explain that they will claim the deduction on their personal tax return.
