Taxable Tips Vs. Non-Taxable Tips: Understanding the IRS Rules Under the New OBBB Guidance

Taxable Tips Vs. Non-Taxable Tips: Understanding the IRS Rules Under the New OBBB Guidance

Published On: December 17, 2025Categories: PayrollTags:

For millions of tipped workers and the employers who pay them, tips are part of taxable income and payroll reporting. With the passage of the One Big Beautiful Bill Act (OBBB), new federal income tax guidance changes how certain tip income is treated for tax years 2025 through 2028. However, payroll taxes still apply, and not all tips are created equal.

In this post we break down:

  • What types of tips are taxable under current IRS rules.
  • What qualifies as non-taxable (deductible) under the new OBBB provisions.
  • How employers and workers need to report and document tip income.

Traditional IRS Rules: All Tips Are Taxable Income

Before the OBBB changes, the Internal Revenue Service clearly states that all tips workers receive are taxable income and must be reported as wages. That includes:

  • Cash tips.
  • Tips added to credit and debit card charges.
  • Shared tips (tip pools).
  • Tips received from other employees under a tip-sharing arrangement.

Under longstanding IRS guidance, employees must report all tips to their employer and they’re included in gross income and subject to federal income tax as well as Social Security and Medicare taxes (FICA/Medicare).

More information and details are available on the IRS website:

The OBBB “No Tax on Tips” Provision: What’s New?

The OBBB created a new above-the-line federal income tax deduction for qualified tips received in tax years 2025 through 2028. This deduction lets eligible workers reduce their federal taxable income by up to $25,000 in qualified tip income per year. However, it does not eliminate FICA/Medicare taxes or state/local taxes.

Under the OBBB guidance:

  • The deduction applies to tax years starting after December 31, 2024 and ending before January 1, 2029. KPMG
  • Workers can deduct up to $25,000 of qualified tips. IRS
  • The deduction phases out at modified adjusted gross income (MAGI) > $150,000 (single) or > $300,000 (married filing jointly). IRS

 

What Makes a Tip “Qualified” Under OBBB?

To be eligible for the tax deduction under OBBB, tips must meet certain criteria:

Voluntary Tips

  • Tips must be voluntarily paid by the customer, not automatically added charges.
  • Service charges and automatic gratuities typically do not qualify

Business Type & Occupation Requirements

  • Employees must work in an occupation that customarily and regularly receives tips as of 12/31/2024.
  • The IRS published guidance and proposed regulations with a list of eligible occupations for the deduction. IRS
  • Tips received in certain “specified service trades or businesses” (like legal, health, accounting, or financial services) are not eligible for the deduction. IRS

This means a restaurant server or bartender might qualify. But a professional who receives occasional gratuities in an unrelated occupation likely won’t.

Non-Qualified Tips

  • Mandatory service charges or auto-gratuities charged by a business and distributed to employees are considered wages, not qualified tips, and don’t count for the deduction.
  • Tips earned in occupations that don’t traditionally receive tips or that fall into excluded categories don’t qualify. IRS

Reporting & Payroll Considerations

Even with the OBBB deduction, all tips must still be reported. Employees must continue reporting their tips to employers and the IRS typically using:

  • Form W-2 (employer reported)
  • Form 4137 — Social Security and Medicare Tax on Unreported Tip Income (for tips reported directly if not on W-2) IRS

Employers should continue proper tip reporting and withholding for payroll taxes (FICA/Medicare). Tips remain subject to Social Security and Medicare taxes regardless of the OBBB deduction. IRS

The new IRS guidance delays mandatory employer reporting of qualified tips (with occupation codes) for tax year 2025, but employers are still strongly encouraged to provide detailed tip records to employees to support deduction claims. IRS

Key Takeaways for Employers and Payroll Professionals

  • The OBBB does not make tips non-taxable — it provides a federal income tax deduction for qualified tips, significantly reducing the tax burden for eligible workers. IRS
  • Payroll taxes (Social Security and Medicare) still apply to all tips. IRS
  • Tip reporting and recordkeeping remain essential — employers should document all tips and work with employees on accurate reporting. IRS
  • Workers should maintain accurate tip logs and use certified IRS guidance to calculate deductions. IRS

Useful IRS Resources

For the full official guidance from the IRS, see the following documents:

  • Notice 2025‑69 – Guidance for Individual Taxpayers Who Received Qualified Tips or Qualified Overtime Compensation in 2025
  • News Release – The Treasury, IRS provide guidance for individuals who received tips or overtime during tax year 2025
  • IRS Facts – One, Big Beautiful Bill Act: Tax deductions for working Americans and seniors

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* MPAY LLC dba Payentry (Company), is not a law firm. This article is intended for informational purposes only and should not be relied upon in reaching a conclusion in a particular area of law. Applicability of the legal principles discussed may differ substantially in individual situations. Receipt of this or any other Company materials does not create an attorney-client relationship. The Company is not responsible for any inadvertent errors that may occur in the publishing process.