On July 4, 2025, President Trump signed the One Big Beautiful Bill Act (“OBBBA”) into law. Among other things, the OBBBA includes a new deduction for tipped workers, referred to as “no tax on tips.” One Big Beautiful Bill Act, H.R.1, 119th Cong. § 70201 (2025).
We know changes to how the federal government taxes tips will impact not only tipped workers but also the businesses that employ them. Here are some common questions we’ve been receiving, along with practical answers to help you ensure that your business is up to speed on the upcoming changes to federal taxation of tips.
Will there actually be “no tax on tips”?
Short answer: No, many tips will still be taxed at both the federal, state, and local levels.
More details:
Federal Taxes on Tips
- The new law includes numerous limitations that cap the extent of the deduction for tipped workers: Tipped workers can only deduct $25,000 in tips annually, even across multiple jobs. Higher-earning workers will be able to claim a reduced deduction. The deduction will be reduced by $100 for every $1,000 a taxpayer’s adjusted gross income exceeds $150,000 (single) or $300,000 (joint). Put into practice this would mean a tipped worker who files a single return, makes $180,000 in AGI, and has $25,000 worth of qualifying tips would still be able to deduct $22,000 (because they make $30,000 more than $150,000, the full $25,000 deduction would be reduced by $3,000). Because the reduction is relatively small, higher-earning workers are still likely able to claim some deduction (though progressively smaller) as long as their AGI does not exceed $400,000 (single) and $550,000 (joint).
- Employees and employers are still required to pay taxes on tips for Medicare and Social Security.
State and Local Taxes on Tips
- The OBBBA only impacts federal taxes and so does not necessarily control how states and localities will decide to tax tips. While some states automatically conform to federal changes through a process known as “rolling conformity,” other states with “static conformity” (including Minnesota) require the legislature to pass a state law to align with the federal changes. Furthermore, some states, such as those without income tax or a definition of income, do not conform to federal income tax law at all.
- For a list of the states that have rolling conformity, static conformity, and no conformity, see Nikhita Airi & Lillian Hunter, Tipped Workers, Their Income Taxes, and States, Tax Policy Center, August 23, 2024, https://taxpolicycenter.org/taxvox/tipped-workers-their-income-taxes-and-states.
- Workers and employers in states with income taxes should check to see whether their state has rolling conformity and, if not, pay attention to changing state laws to determine whether they will need to pay state and local taxes on tips.
When will this take effect?
Short answer: Retroactively, starting January 1, 2025.
More details:
- The deduction takes effect for the tax year after December 31, 2024, and applies retroactively to the beginning of the tax year. This means tips earned from January 1, 2025, to the present may qualify as “qualified tips” for the 2025 deduction. 2025 will likely be a transitional year as the OBBBA takes effect midway. Many tax forms will require updates to accurately reflect the information necessary for assessing taxes under the new scheme. Employers should ensure they are using the latest IRS forms to stay on top of these changes. Current forms are available on the IRS website at https://www.irs.gov/forms-instructions.
Do employers and workers still need to track and report tips?
Short answer: Yes, there are no changes to the tracking and reporting requirements for tips.
More Details:
- Employees still need to report their tips to their employer in writing as well as on their individual income tax return.
- Employers still need to report tips on employees’ Forms W-2. Employers also need to withhold the employee’s share of Social Security and Medicare taxes based on wages and tips and pay the accompanying employer’s share.
- The OBBBA only applies to “cash” tips but defines the term broadly to include tips made in cash, charged, or made under any tip-sharing arrangement.
Will there still be taxes on service charges?
Short answer: Yes, mandatory charges are not considered “qualified tips” and will not count toward the deduction.
More Details:
- The OBBBA applies only to tips that are (1) paid voluntarily without any consequence in the event of nonpayment, (2) not the subject of negotiation, and (3) determined by the payor. Because service charges are generally mandatory and determined by the business, payment from service charges would not constitute “qualified tips” under the OBBBA.
- Accordingly, businesses may want to consider the impacts of existing and potentially new service charges, consistent with state law, on tip-earning employees’ take-home pay.
Do employers need to change withholdings?
Short Answer: Generally, no, at least not in the short term.
More Details:
- Because the OBBBA does not impact Medicare and Social Security taxes, employers likely will not see a change in withholdings for the employee or employer portion of these taxes.
- Because an employee’s tax obligations may change due to the deduction, it would not be surprising to see changes to Forms W-4 (Employees Withholding Certificate) and withholding tables in tax year 2025 to allow employees to more accurately adjust withholdings down to match up with lower tax obligations. Employers should watch for likely updates to the W-4 form and withholding tables in the coming year, which will be posted on the IRS’s website at https://www.irs.gov/forms-instructions.
Should employers attempt to pay other workers with tips to maximize the benefits of the deduction?
Short Answer: Generally, no, unless they are part of an occupation that has historically used tips as a form of compensation.
More Details:
- Workers and employers outside of occupations that are traditionally tipped likely would not be able to seek the deduction. The OBBBA applies only to tips received in an occupation that “customarily and regularly received tips on or before December 31, 2024.” The Secretary of the Treasury is required to publish a list of qualifying occupations within 90 days of enactment, which should provide greater clarity about which occupations are eligible for the deduction. Furthermore, the OBBBA also explicitly prohibits the use of the deduction for specific industries, including:
- Health
- Law
- Accounting
- Actuarial Science
- Performing Arts
- Consulting
- Athletics
- Financial Services
- Brokerage Services
- Trade or business where the principal asset is the reputation or skill of the employees or owners
- Trade or business that deals in investing, management, trading, or dealing in securities, partnership interests, or commodities
- These provisions suggest there isn’t much room for expanding the use of tips beyond industries and occupations where tipping already is a custom or practice.
- If an employee works in an occupation where tips would be customary, employers have the option to reevaluate whether they would like to adjust their payment structure to increase compensation through tips. When determining whether to restructure payment, employers should keep in mind:
- That the deduction is capped at $25,000
- That the deduction is set to sunset in December of 2028
- The value of predictable and stable wage payments
- The preferences of employees based on their individual tax situation
- Finally, employers considering expanding the pool of individuals eligible for tips should carefully follow Minnesota’s tip pooling rules, which specify who is eligible to participate in tip pools. Employers are strongly advised to consult with legal counsel before starting or enlarging a tip pool.
