No Tax on Tips: What HR and Payroll Professionals Need to Know

The U.S. Treasury Department and IRS have proposed new regulations that could significantly impact tipped workers across the country. Under the “No Tax on Tips” provision, which is part of the One Big, Beautiful Bill Act (OBBBA), eligible workers may deduct up to $25,000 in qualified tips from their taxable income starting with the 2025 tax year. Understandably, this has sparked excitement across service industries. But while the headlines promise tax relief for tipped workers, many businesses are misunderstanding key aspects of the regulation. These misconceptions could lead to compliance issues, missed opportunities, or even IRS scrutiny.

Let’s break down what employers often get wrong and what they need to know.

#1. It’s Not a Payroll Tax Exemption

Misconception: Employers think they no longer need to withhold or report tip income.

Reality: The deduction applies only to federal income tax on the employee’s personal return. Employers must still withhold and report tips for Social Security, Medicare, and unemployment taxes. Form W-2 reporting remains unchanged for 2025 (https://rsmus.com/insights/services/business-tax/no-tax-on-tips-rules.html).

#2. Not All Tips Qualify

Misconception: Any money received by an employee counts as a deductible tip.

Reality: Only “qualified tips” are eligible. These must be:

• Voluntarily paid by customers
• Received in cash or equivalents (credit cards, mobile payments, etc.)
• Properly reported on W-2, 1099, or Form 4137

Not qualified:

– Mandatory service charges (e.g., automatic 18% gratuity) (https://www.irs.gov/newsroom/treasury-irs-issue-guidance-listing-occupations-where-workers-customarily-and-regularly-receive-tips-under-the-one-big-beautiful-bill)

#3. It Doesn’t Apply to All Employees

Misconception: Any employee who receives tips can claim the deduction.

Reality: Only workers in IRS-approved occupations that “customarily and regularly receive tips” are eligible. https://natlawreview.com/article/tip-jar-revolution-irs-unveils-preliminary-tipped-jobs-list-no-tax-tips-deduction)

The list includes 68 occupations, such as:

• Bartenders, servers, baristas
• Hair stylists, massage therapists
• Tour guides, water taxi operators
• Landscapers, electricians, plumbers, appliance installers, HVAC techs, home cleaners, locksmiths

# 4. Employers Still Play a Critical Role

Misconception: The deduction is the employee’s responsibility, so employers don’t need to do anything.

Reality: While employees claim the deduction on their personal tax returns, employers must:

– Accurately track and report tips

– Ensure job titles match IRS definitions

– Maintain clear records for audits or employee inquiries (https://hrdailyadvisor.com/2025/08/29/what-employers-should-know-about-no-tax-on-tips/)

# 5. It’s Temporary and Income-Limited

Misconception: This is a permanent change to tax law.

Reality: The deduction is temporary, applying only to tax years 2025–2028. It also phases out for individuals earning over $150,000 (or **$300,000** for joint filers (https://home.treasury.gov/news/press-releases/sb0258)

Navigate Employment Law Compliance with Landrum HR Solutions

The “No Tax on Tips” provision is a powerful tool for supporting tipped workers, but only if businesses understand how it works. HR and payroll teams should:

– Review tip reporting systems

– Educate employees on eligibility

– Stay tuned for final IRS guidance

Staying compliant with changing employment laws like the new “no tax on tips” legislation can be challenging for any employer. Landrum HR Solutions helps you stay ahead of these updates by providing expert HR guidance and compliance support. Partner with us to simplify compliance so you can focus on running your business with confidence.