George Bonini from Foster Garvey joined us to host an informative presentation and discussion on what the “No Tax on Tips” policy means for restaurants and their employees.
Here are some resources from the presentation.
Historically, tips were considered income and were therefore taxable. However, after a bipartisan push in the 2024 election and congress, “No Tax on Tips” was passed earlier this year in the “One Big Beautiful Bill.”
No tax on tips
What is it?
- There is now a federal income tax deduction of up to $25,000 per year for qualified tips received by employees and self-employed individuals in specified occupations, effective for tax years 2025 through 2028.
- This does not fully exempt tip income from tax but instead allows eligible occupations to deduct the first $25,000 of tip income from their adjusted gross income, providing major tax relief for workers in jobs that customarily and regularly receive tips.
- Expressly includes hospitality
- Also, there is no tax on overtime
Law Details:
- Qualified tips are cash tips received by an individual in an eligible occupation that customarily and regularly received tips on or before Dec. 31, 2024.
- Proposed regulations state, “cash (or a cash medium such as charges, gift cards, etc.) tips received from customers, or in the case of an employee, though a mandatory or voluntary tip sharing arrangement such as a tip pool.”
- Only voluntary tips paid at the discretion of the customer are eligible. To be a qualified tip:
- The payment must be made free from compulsion.
- The customer must have the unrestricted right to determine the amount of the tip.
- The payment should not be the subject of negotiation or dictated by employer policy.
- Generally, the customer has the right to determine who receives the payment.
- The proposed regulations are expected to expressly state that “service charges, automatic gratuities and other mandatory amounts automatically added to a customer’s bill are not qualified tips.”
Eligibility Requirements:
- A valid Social Security number is required (undocumented workers are ineligible).
- Married taxpayers must file jointly to claim the deduction.
- The deduction phases out for individuals with a modified Adjusted Gross Income (AGI) over $150,000 and for married couples with AGI over $300,000. Can be a bit of a tricky calculation, including other deductions, credits or exclusions.
Mandatory Service Charges:
- Shared service charges—such as mandatory gratuities or automatic charges added to a bill for large parties—are not eligible for the no-tax-on-tips deduction. Only voluntary tips, either paid directly by customers or shared through tip pools among employees, qualify for this federal tax benefit.
- A qualified tip must be voluntary, not subject to negotiation and paid by the customer by their own choice.
- Mandatory service charges (for example, a required 18% added to restaurant bills for large tables) are considered non-tip wages or service charges and are specifically excluded from the tips deduction provisions under the One Big Beautiful Bill Act (OBBBA).
- IRS guidance and proposed regulations clarify that any automatic gratuities or employer-mandated charges distributed to employees are ineligible for the $25,000 annual tip deduction.
- Guidance from Washington law – service charges subject to B&O tax, tips with a clear voluntary opt-in or defaulting to 0%—are not subject to B&O tax because they are directed to employees.
Employer Responsibilities:
- Reporting Requirements: Employers must separately report all tips employees receive on Form W-2. Employers must report total cash tips and employees’ qualifying occupations on Form W-2 or 1099 as applicable. Taxpayers must include social security numbers on returns for the deduction to apply.
- FICA Taxes Remain Owed: FICA taxes (Social Security and Medicare taxes) will still be due from both the employee and the employer. That is, the allowed $25,000 credit will still be taxable income for purpose of these taxes.
- Withholding Adjustments: Withholding tables will be updated for the 2026 tax year to reflect this deduction. For 2025, employees may realize the benefit when they file their tax return and receive a refund.
No Tax on Overtime
- The Act also creates a tax deduction for “qualified overtime compensation.” Qualified overtime compensation is defined as “overtime compensation paid to an individual required under section 7 of the Fair Labor Standards Act of 1938 that is in excess of the regular rate.” Typically, the majority of hourly workers.
- Workers can deduct $12,500 in overtime pay from their income. As with the tax on tip, this deduction also has no effect on Social Security and Medicare taxes. There is an income phase-out same as the tip deduction.
- Similar to the tip deduction, this deduction is also available in addition to the standard deduction (i.e. an above the line deduction). Employers will need to report the total amount of qualified overtime compensation on their employees’ Forms W-2 (and possible form 1099).
We would like to extend our appreciation and a thank you to Terra Plata for hosting the Seattle Restaurant Alliance October membership meeting!
Next SRA Meeting:
Our next meeting will be Nov. 5 with a panel discussion on restaurant rebranding, when to do it, tips on how to do it and how much it takes. Follow updates from the Seattle Restaurant Alliance for location information.