"No tax on tips" is the most misunderstood tax change to hit restaurants in years. Servers think tips are now tax free. Owners think it is the employees' problem. Both are wrong, and the owner's mistake is the one that costs money.
The deduction lives in IRC 224, added by Public Law 119-21 in July 2025. It belongs to the employee. But whether an employee can claim it depends heavily on what you report, how your POS system asks for tips and whether you keep service charges separate. Here is what you need to know as the employer.
What the deduction is, and what it is not
Section 224 allows an individual a deduction for qualified tips received during the year, up to $25,000. Under section 224(b)(2), the deduction shrinks by $100 for each $1,000 of modified adjusted gross income above $150,000, or $300,000 on a joint return. Married taxpayers must file jointly, and the return must include the Social Security number of the person who received the tips. Under section 224(h), the deduction is not allowed for tax years beginning after December 31, 2028. The IRS describes it as applying to tax years 2025 through 2028.
What it is not: it is not an exclusion from wages and it does not touch FICA. Section 224 is an income tax deduction. Reported tips are still wages under IRC 3121(q). You still withhold, still pay the employer share of Social Security and Medicare and still deposit. Nothing about your duties under IRC 6053 changed. If a server tells you they no longer need to report tips, they are wrong, and you should tell them so in writing. Our guide to the owner's tip reporting duties covers the baseline rules that still apply.
Your W-2s now carry the deduction
Section 224(a) allows the deduction only for qualified tips included on certain information statements, including the employee's Form W-2 under IRC 6051(a)(18), or reported by the employee on Form 4137. Section 6051(a)(18) requires the employer to show on the W-2 the total cash tips reported by the employee under section 6053(a) and the employee's occupation.
The IRS's tip recordkeeping guidance says employers must separately report the total cash tips reported to the employer on Form W-2 in box 12 using code TP, and include the applicable Treasury Tipped Occupation Code in box 14b. In plain terms, your payroll system now has to know two things about every tipped employee: how much in cash tips they reported, and which tipped occupation they work in.
The occupation codes
The occupations that qualify are listed in Treas. Reg. 1.224-1(h), which assigns each a Treasury Tipped Occupation Code. The beverage and food service group includes:
| Code | Occupation |
|---|---|
| 101 | Bartenders |
| 102 | Wait staff |
| 103 | Food or beverage servers, non-restaurant |
| 104 | Dining room and cafeteria attendants and bartender helpers (bussers, bar backs) |
| 105 | Chefs and cooks |
| 106 | Food preparation workers |
| 107 | Fast food and counter workers (including baristas) |
| 108 | Dishwashers |
| 109 | Host staff |
| 110 | Bakers |
Restaurant managers are not on the list. The regulation's examples say a tip handed to a manager acting as a manager is not a qualified tip, while a tip received directly by a manager who is waiting tables during a rush can be.
Service charges and automatic gratuities
This is where restaurants will get tripped up. Section 224(d)(2)(A) requires that a qualified tip be paid voluntarily without any consequence for nonpayment, not be the subject of negotiation and be determined by the payor. Treas. Reg. 1.224-1(c)(4) applies that directly: service charges, automatic gratuities and other mandatory amounts added to a customer's bill are not qualified tips, even if you later distribute them to employees.
The regulation's first example is a restaurant that adds an automatic 18 percent charge for parties of six or more. Not a qualified tip. If the customer adds 2 percent on an "additional tip" line, that 2 percent is a qualified tip.
A "recommended tip" printed on the bill is different. If the customer is expressly given the option to change it, including to zero, the amount the customer chooses can be a qualified tip.
Mandatory service charges were already wages, not tips, for payroll purposes. If your system has been lumping them together, the W-2 reporting under section 6051(a)(18) will now magnify the error, because those amounts would show up as cash tips eligible for a deduction they cannot support.
Your POS tip screen matters now
The regulation has three examples that read like they were written by someone who eats out a lot:
- A handheld POS device offers 15, 18 or 20 percent, "other" and "no tip." The customer picks 18 percent. That is a qualified tip, because the customer could leave nothing.
- A device offers only 15, 18 or 20 percent and the customer must pick one. The amount is not a qualified tip, because the customer was forced to choose an amount greater than zero.
- Same forced screen, but the customer picks 18 percent. Only the 3 percent above the forced 15 percent minimum is a qualified tip.
A tip slider that can go to zero works. A slider with a floor means only the amount above the floor can qualify. If your screen has no zero option, reprogram it. You are otherwise building a reporting problem into every card transaction.
Tip pools and the anti-abuse rules
Treas. Reg. 1.224-1(c)(2) includes tips received through a mandatory or voluntary tip-sharing arrangement, such as a tip pool, as cash tips. But under paragraph (c)(10), amounts a manager or supervisor receives through a tip pool are not qualified tips.
The anti-abuse rules in paragraph (c)(11) matter to owners. There is an irrebuttable presumption that an amount is a recharacterization of wages, and not a qualified tip, if the employer is the payor of a tip to its own employee. The same presumption applies if the tip recipient has a direct ownership interest in the payor of 5 percent or more. Do not try to convert wages or bonuses into "tips." The regulation was written with that move in mind.
The 2025 transition year
For tax year 2025, the IRS acknowledged that employers did not have systems in place. Notice 2025-62 provided that the IRS will not impose information return penalties under IRC 6721 or 6722 for 2025 if an employer fails to separately report cash tips or the employee's occupation on the W-2, as long as the W-2 is otherwise complete and correct, including the tips in the total wages. The notice encouraged employers to give employees occupation codes and separate tip totals through a portal, a separate statement or another secure method anyway.
Treas. Reg. 1.224-1(d)(2) has a matching rule for employees: for tax years beginning before January 1, 2026, qualified tips need only be included in the aggregate amount on the statement, not separately reported.
That relief was for 2025 only. For 2026 W-2s, plan on full compliance.
What to do this year
- Map every tipped job title to a Treasury Tipped Occupation Code and load it into payroll.
- Separate service charges from tips in the POS and in payroll, with different pay codes.
- Fix any tip screen that lacks a zero option.
- Identify managers and supervisors who share in tip pools, and tell them in writing that the regulation treats those pool amounts as not qualified tips.
- Remind employees that FICA and tip reporting rules have not changed.
None of this changes your employer FICA exposure, and it does not change the FICA tip credit under IRC 45B, which is covered in our guide to Form 8846. Large establishments should also make sure Form 8027 figures tie to the new W-2 reporting; see our Form 8027 guide. If payroll problems are already piling up, the firm's payroll tax page explains how it approaches them.
The deduction is your employees' benefit. The paperwork that makes it work is yours.