No Tax on Tips: How Is Payroll Affected?

^{This article was updated 8/21/2025 to reflect the proposed 2026 Form W-2 changes.}

Tipped income is already complicated, and it just got more so. With the passage of the One Big Beautiful Bill Act (OBBA), major tax changes are here in 2025. One of the biggest? Certain tipped employees will no longer pay federal income tax on their tips.

The new law, signed by President Trump on July 4, 2025, also introduces a deduction for no tax on overtime pay, increases the standard deduction, and increases the child tax credit. But for service workers and their employers, the “no tax on tips” provision is the headline change.

Here’s what to know.

Overview of tipped income and taxation

Some employees (e.g., restaurant servers, nail technicians, etc.) regularly and customarily receive tips as part of their compensation. If an employee regularly receives more than $30 in tips per month, they are officially a tipped employee under the Fair Labor Standards Act (FLSA).

Customers typically leave cash tips or electronic tip payments (e.g., via credit and debit card), or employees can receive tips from a tip pooling agreement. According to the IRS, these are all considered “cash tips.”

Employers must pay tipped employees at least the tipped minimum wage, which varies by state. The tipped minimum wage is a lower hourly rate than the regular minimum wage.

How do taxes on tips work? Employees must report all tips to their employers if they receive $20 or more tips during a month. All reported tips are subject to federal income, Social Security, and Medicare taxes (plus state and local taxes, where applicable). 

As the employer, you must withhold taxes from the employee’s tipped income, remit it to the proper agencies, and report the income and taxes on Form 941 and the W-2 form for employees. 

What are the “no tax on tips” changes?

Starting in 2025 and going through 2028, cash tips that an individual receives in an occupation that traditionally and customarily receives tips qualify for a federal income tax deduction for the total tipped income received.

Tipped deductions max out annually at $25,000. Also for self-employed tax payers, the deduction cannot exceed the individual’s net income from the trade or business the tips were earned.

Several states are also noodling a no tax on tips and overtime law.
Several states (e.g., Alabama, North Carolina, and New Jersey) have also proposed legislation to eliminate state income tax on tips and overtime pay.

What type of occupations qualify for the tip tax deduction?

The following tipped services are examples that would qualify for the tax deduction:

• Providing, delivering, or serving food or beverages for consumption
• Barbering and hair care
• Nail care
• Esthetics
• Body and spa treatments 

The IRS has also made it clear that eligible occupations must have customarily received tips on or before December 31, 2024. In other words, they’re basing it on tipping patterns from the prior year.

Watch for the Secretary of the Treasury to publish an official list of jobs that qualify for the tax deduction by October 2, 2025.

What tipped employees don’t qualify under the new tax deduction?

The Fair Labor Standards Act definition of a tipped employee (anyone who regularly earns more than $30 per month in tips) is used to determine whether an employer can pay an employee the lower tipped minimum wage.

However, the “no tax on tips deduction” in “The One, Big, Beautiful, Bill” uses a much narrower definition of who qualifies. So, even if someone meets the FLSA standard for being a tipped employee, they may not qualify for the federal tip deduction.

Employees who don’t qualify for the “no tax on tips” deduction:

• High earners: This is defined as making over $160,000 per year. This cap applies regardless of how much tip income is earned.
• Jobs where tipping isn’t customary: Examples of non-qualifying jobs are, hotel front desk or concierges, retail workers, gig workers. This will be defined by the Secretary of State by October 2025.
• Employees who don’t report tips to their employer.
• Nonresident aliens: Typically, foreign nationals who don’t meet the substantial presence or green card test.

How should employers handle the “no tax on tips” in payroll?

The IRS has announced no payroll or withholding changes apply for the 2025 tax year. If you run payroll for tipped employees, you’ll continue withholding, remitting, and reporting taxes on tips exactly as you always have.

Why? Because the new tip deduction doesn’t reduce taxable income when tips are earned. Employees can only claim it later, when they file their 2025 federal tax return in 2026.

That said, employees who expect to benefit from the deduction may choose to adjust their Form W-4 to lower their withholding. If they do, you’ll need to update payroll accordingly.

Changes coming to the 2026 Form W-2

The IRS has released a draft of the 2026 Form W-2, and it includes new fields tied to the “no tax on tips” law. These apply to 2026 wages (W-2s issued in January 2027):

• Box 12 gets new codes:
  • TP for qualified tips
  • TT for qualified overtime pay
  • TA for contributions to the so-called “Trump Accounts” (another OBBBA benefit)
• Box 14 updates:
  • Box 14a will remain as the informational box for reporting information such as state disability insurance taxes withheld, S Corp health insurance premiums.
  • Box 14b will hold a “tipped occupation code” so the IRS can match the deduction to approved tipped jobs.

For employers, 2025 is a transition year: you’ll still report tips and overtime the old way, but the IRS expects employers to reasonably approximate these amounts so employees can claim them. By 2026, the W-2 will catch up and include the proper boxes and codes.

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“No tax on tips” FAQs

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This article has been updated from its original publication date of May 15, 2025.

This is not intended as legal advice; for more information, please click here.