No Taxes on Tips Explained: What it Means for Business Owners

If you’ve been hearing buzz about “no tax on tips” in 2025, you might be wondering what it really means for your team and whether you can stop worrying about payroll headaches. Let’s clear this up right away: no, tips aren’t suddenly tax-free across the board.

The new law, passed as part of the One Big Beautiful Bill Act (OBBBA), creates a federal income tax break for certain tipped workers, but it does not erase your reporting or withholding obligations as a business owner. In fact, it adds new rules you’ll need to understand to keep your payroll compliant.

Will There Be No Tax on Tips in 2025?

Short answer: No. Despite the headlines, tips are not completely tax-free. The One Big Beautiful Bill’s passage created a new federal income tax deduction for tipped workers, not an outright elimination of tax on tips.

Here’s how it works:

• Eligible employees can deduct up to $25,000 in qualified tips per year from their federal income tax.
• This deduction applies to tips received in occupations where tipping is customary, like servers, food preparation workers, food delivery, parking attendants, room attendants, booth cashiers, cafeteria attendants, housekeeping cleaners, and other eligible workers to be confirmed by the Treasury Department.
• Tips still count toward gross income, and employees must still report them.

So, while workers may see lower federal income tax liability, employers and employees are still responsible for Social Security taxes, Medicare, and state and local taxes unless their state decides to follow the federal lead.

How Long Does the No Tax on Tips Provision Last?

The “No Tax on Tips” Provision is set to last until the end of 2028.

The tips provision in the Big Beautiful Bill Act took effect retroactively starting January 1, 2025 and is set to sunset after December 31, 2028. That means employers and tipped workers can claim the deduction for the 2025, 2026, 2027, and 2028 tax years—unless Congress extends it.

This timeline makes 2025 a transition year. Employers should expect updated forms and reporting rules from the IRS. The Treasury Department will also publish an official list of eligible employees and industries that qualify.

The Misconception vs. Reality For Business Owners Who Employ Tipped Workers

Misconception: “No taxes on tips” means I don’t need to report tips anymore.

Reality: Employers must still report, withhold, and pay tax on tips.

Even though tipped employees may be able to deduct part of their tips on their federal income tax return, the obligations for business owners remain:

• Accurate reporting of all tips.
• Federal income tax withholding for employees.
• FICA and FUTA contributions (Social Security and Medicare).
• W-2 reporting of tipped income.

The new law creates a tax break for workers, not an escape hatch for businesses.

Federal Income Taxes vs. State and Local Taxes

The OBBBA only changes federal law. Whether tips remain taxable at the state or local level depends on how your state handles conformity to federal income tax law:

• Rolling conformity states automatically adopt federal changes.
• Static conformity states (like Minnesota) require separate state legislation to align with federal rules.
• Non-conforming states with no income tax or their own definitions of income may not follow the federal deduction at all.

That means a tipped worker in one state may see no tax on tips at both the federal and state levels, while a worker across the border may still pay full state income tax. Employers should monitor state-level changes closely to avoid surprises.

How the One Big Beautiful Bill Act Affects Tax on Tips

The Big Beautiful Bill Act creates a new deduction but keeps other taxes in place:

• Up to $25,000 in qualified tips can be deducted each tax year.
• The deduction phases out as modified adjusted gross income increases. For singles, the deduction decreases $100 for every $1,000 of income above $150,000; for joint filers, the phaseout begins at $300,000.
• The deduction fully phases out at $400,000 (single) or $550,000 (joint).

Example: A single worker with $180,000 AGI and $25,000 in tips would still get a $22,000 deduction. That’s a meaningful tax break, even at higher income levels.

But here’s what doesn’t change:

• Tips are still part of gross income.
• Social Security taxes and Medicare apply.
• Employers still have reporting, withholding, and filing obligations.

Helpful “Tips” For Business Owners

Running a business with tipped workers now requires even closer attention to payroll and reporting. The “no tax on tips” headlines don’t change your core responsibilities; they simply add a new layer of rules to follow.

Employers still need to track tips received, manage federal income tax withholding, and ensure compliance with Social Security and Medicare requirements. The key takeaway is this: your reporting obligations haven’t gone away, but your employees may now qualify for a federal tax break.

Accurate Reporting

Nothing changes — tips must still be tracked and reported.

Employees must report tips in writing to their employer, and employers must record them on Form W-2. Employers should continue requiring employees to submit tip records regularly to avoid underreporting.

Federal Income Tax Withholding

Withholding rules are still in play.

Even though employees may claim a deduction on their tax return, you still need to withhold federal income tax on tips. Expect updates to Form W-4 and withholding tables in the 2025 tax year to help employees align their withholding with their reduced federal tax obligations.

FICA and FUTA

These taxes are unchanged.

Employers and employees must still pay Social Security taxes and Medicare on all tipped income. FUTA also applies. The “no tax on tips” headlines have no impact on these payroll taxes.

Tip Allocation

Employers in industries with tip-sharing or tip pool arrangements should continue business as usual. The OBBBA counts “qualified tips” broadly, including cash tips, credit card tips, and tips distributed through a tip-sharing or tip pool arrangement. But remember, service charges are not tips and don’t qualify for the deduction.

The Importance of Compliance

The IRS is likely to increase scrutiny of tipped income during the early years of this law. Employers should:

• Continue collecting and verifying tip reports.
• Use updated IRS forms once released.
• Train payroll staff on the distinction between qualified tips and service charges.
• Avoid experimenting with new “tipped” pay structures unless they are part of traditionally tipped occupations.

Failure to comply could lead to penalties, interest, and IRS audits — far outweighing any short-term benefit of sloppy reporting.

How a Tax Strategist Can Help

“No tax on tips” sounds simple in theory, but in practice, it’s layered with rules, exceptions, and deduction phases.

A tax strategist helps you:

• Identify which employees are eligible workers under Treasury guidance.
• Ensure accurate federal income tax withholding and payroll compliance.
• Evaluate whether restructuring compensation makes sense for your team.
• Track deduction limits, modified adjusted gross income thresholds, and sunset dates.
• Monitor state and local taxes for non-conforming rules.
• Plan for 2029, when the tips provision could expire.

FAQs About “No Tax on Tips” Provision

Are all tips tax-free now?

No. Only qualified tips are eligible for the new deduction, and they must be paid voluntarily by the customer. Mandatory service charges or negotiated fees still do not count.

Do self-employed individuals qualify for the tip deduction?

Generally, no. The deduction was designed for employees in occupations where tips are customary. Self-employed individuals like independent contractors must still report and pay tax on all earned income, including any tips.

Which occupations qualify as “certain workers”?

The Treasury Department has released a list of 68 occupations that qualify. It includes the typical occupations you’d expect, like bartenders and servers, but also includes some surprising trades such as shoe and leather workers, charter boat workers, guest services, baggage porters, gambling change persons, pet caretakers, tattoo artists, portrait photographers, and more.

Do employers and employees still have reporting requirements?

Yes. Nothing changes about reporting requirements. Employees must continue to report received tips to their employer in writing and on their income tax return. Employers must still report tips on Forms W-2, withhold federal income tax, and pay their share of Social Security and Medicare.

Does the law apply to debit card or credit card tips?

Yes. The law defines tips broadly, so tips paid in cash, charged to a debit card or credit card, or distributed through a tip pool are all eligible if they meet the definition of qualified tips.

Who signed this into law?

The no tax on tips provision was included in the Big Beautiful Bill Act, signed by President Trump in 2025.

What about service charges?

Service charges are not considered qualified tips. Because they are mandatory and set by the business, they don’t count toward the deduction.

What This Means for Your Business Moving Forward

The promise of “no tax on tips” makes for great headlines, but the reality is more nuanced. Business owners still have major responsibilities when it comes to reporting, withholding, and compliance. Employees may enjoy meaningful tax deductions, but Social Security, Medicare, and local taxes remain.

The smartest move you can make as a business owner is to treat this new law as an opportunity — not a free pass. Work with a strategist who understands the Big Beautiful Bill Act and can help you maximize tax deductions while keeping your payroll airtight.

At OTB Tax, that’s what we do every day: free up money for our clients legally, morally, and ethically.

Ready to make sure you’re not leaving money on the table? Contact OTB Tax today and let’s put a real strategy in place.