On July 4th, 2025, President Trump signed a new tax and spending bill into law. The bill contains a number of provisions that will have a direct impact on the restaurant industry. However, the provision that has received the most attention among restaurant owners, operators and employees is the No Tax on Tips rule.
“Obviously this is something that a lot of restaurant owners and operators are talking about right now,” says Head of Back of House, Nick Florek. “I think the main question on everybody’s mind is, ‘what does this mean for my business?’”
The new rule could mean more take-home pay for restaurant employees by reducing what they owe for federal income tax each year. But what does it mean for your restaurant? As a restaurant operator, you will need to understand the new rule so that you can support your team and meet your new reporting requirements.
Disclaimer: We are neither lawyers nor accountants. The information in this article is for informational purposes only. For actual tax advice, we strongly recommend speaking with a tax professional.
With that in mind, here's what you need to know.
How the No Tax on Tips Rule Works
- Tipped employees will be able to deduct up to $25,000 in qualified tips from their federal taxable income.
- This provision goes into effect beginning in the 2025 tax year (i.e. the year for which you will file taxes on or before April 15, 2026). The provision remains in effect through 2028.
Key Terms
- A tax deduction reduces the total amount of a taxpayer’s that is considered taxable. This should not be confused with a tax credit, which reduces the total amount of money a taxpayer owes on their tax bill for the year.
- The new rule is an above-the-line deduction. This type of deduction reduces a taxpayer's adjusted gross income (the amount used to calculate an individual’s total tax bill) regardless of whether the taxpayer itemizes deductions or takes the standard deduction.
No Tax on Tips In Action
The National Restaurant Association provided a basic demonstration of how the math works out for restaurant employees:
- Before the No Tax on Tips provision, a server earning $20,000 in hourly pay and $30,000 in tips would have paid federal income tax on $50,000.
- Under the new provision, this server can now deduct up to $25,000 from the tipped portion of their income. This would bring the server's taxable income down to $25,000 ($20,000 in hourly pay and $5,000 in tips after the deduction).
- A server in the 22% tax bracket would save an estimated $5,500 on their federal taxes.
Who Qualifies For No Taxes on Tips
“There are quite a few industries that will be impacted by this new No Tax on Tips rule,” says Nick. “But I think we’ll feel it most profoundly in the restaurant industry because so many workers in our field rely on tips as their primary source of income.”
The Treasury Department lists nearly 70 eligible occupations, including the following restaurant roles:
- Front of house: Servers, bartenders, hosts/hostesses, food runners, bussers, and baristas
- Back of house: Chefs, cooks, and dishwashers who receive tips either directly or through tip pooling arrangements
- Support roles: Valet drivers, coat check attendants, and even musicians performing at your restaurant can take advantage of the deduction
- Delivery: Drivers and food delivery workers, whether they're W-2 employees or working through gig platforms
Important Note: Existing labor law prohibits managers and supervisors from participating in tip pools, and therefore from receiving the new tip deduction.
Limitations on the Tip Deduction
The maximum amount that a tipped employee can deduct is $25,000. However, in some cases, the person will not be able to take that big a deduction.
Self-Employed Workers
Independent contractors (such as 1099 delivery drivers) can only deduct up to their net income from tip-based work. If a delivery driver earns a net income of $18,000 through tips, they would be able to deduct that $18,000 from their taxable income, but not take the full $25,000 deduction.
Single-Filing High Earners
According to the IRS, “higher earners” may only qualify for a partial deduction. Single-filing higher earners are those who file as a single individual while earning $150,000 or more in Modified Adjusted Gross Income (MAGI). For every $1,000 earned over this threshold, the possible deduction for a filer would be reduced by $100.
- For example, a single filer earning $160,000 would be $10,000 over the limit, so their maximum deduction would be reduced by 10 x $100, or $1,000, and thus drop from $25,000 to $24,000.
Joint-Filing High Earners
Joint-filing higher earners are those households earning $300,000 or more in Modified Adjusted Gross Income (MAGI). For every $1,000 earned over this threshold, the possible deduction for a household would be reduced by $100.
- For example, joint filers earning $310,000 would be $10,000 over the limit, so their maximum deduction would be reduced by 10 x $100, or $1,000, and thus drop from $25,000 to $24,000.
What Counts as a Qualified Tip
“This new tip deduction only applies to ‘qualified tips,’” explains Nick. “As a restaurant operator, you need to understand what that means so you can put your employees in the best possible position to maximize their tax benefits.”
So what exactly are qualified tips? First and foremost, in order to be qualified, tips must be reported to the IRS and they must be included on a W-2. Tips that go unreported will not be eligible for deduction.
In addition, H&R Block says that qualified tips are those that are:
- Given by customers voluntarily
- Determined solely by the customer
- Not based on a negotiated number
Tips That Qualify
- Cash tips paid directly by customers
- Credit card tips
- Tips distributed through tip pooling arrangements
- Suggested tip amounts. For instance, if a restaurant includes suggested tip amounts on a receipt, the final tip amount would still be decided by the customer, and would therefore be considered voluntary.
Tips That Do Not Qualify
- Mandatory service charges added to bills for large parties, banquets, or catering
- Negotiated gratuities that are automatically added and can only be removed after discussion
- Surcharges (like a 3% fee added to every bill for labor costs)
- Non-cash tips such as comped meals, event tickets, or exchanged services
Tips That Partially Qualify
- Auto-gratuities do not qualify for deduction. However, any amount that a customer tips above this auto-gratuity does qualify for dedication. So if a restaurant charges an automatic 18% gratuity for large parties and a customer tips 20% total, only 2% of that tip would qualify for deduction. The remaining 18% would be considered a non-voluntary service charge as opposed to a qualified tip, and would therefore not be eligible for deduction.
A Closer Look at Auto-Gratuities
The new rule could actually change the way a lot of restaurants handle gratuities. According to CNBC, the National Restaurant Association says that 54% of full-service operators and 67% of fine-dining restaurants add an automatic gratuity to at least some customer checks. Among those that do, 88% apply it only to large parties (typically six or more) or to banquets, private events, and catering.
“In most cases, the reason restaurants charge an automatic gratuity is to protect their employees from getting stiffed on larger bills,” says Nick. “But under the new rule, charging this automatic gratuity could actually prevent your staff members from receiving their full tax benefits. So as a restaurant operator, you’ll want to think carefully about whether or not auto-gratuities still make sense for you.”
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Important Tax Changes For Restaurant Operators
Reporting Requirements
The No Tax on Tips bill adds a few additional reporting requirements for owners and operators. According to the IRS, if you employ tipped workers, the new law requires you to:
- File information with the IRS or Social Security Administration (SSA), and;
- Provide statements to each employee showing:
- The total amount of cash tips they received during the year
- The occupation of the tip recipient
This information will be reported on W-2 forms. The IRS has also said that it will provide transition relief to employers while they adapt to these new requirements for tax year 2025. This means you will not be penalized for failing to meet certain reporting requirements during the first year of implementation.
For more details on transition relief and how to avoid penalties while you adjust, consult the rules posted by the IRS.
Tax Withholding Requirements
- Tipped income falling below the $25,000 threshold will not require federal income tax withholding.
- Withholding will apply to any tipped income above this $25,000 threshold.
- As an employer, it is your responsibility to ensure that your payroll provider is handling the new withholding rules correctly.
The FICA Tip Credit
The FICA tip credit will remain in effect. The FICA tip credit (or the Section 45B tip credit) is a credit that was created to provide tax relief to businesses in which tipping is customary. Employers are legally required to pay FICA taxes on all reported tip income, even though the money is paid directly to employees rather than the business.
The FICA tip credit is a non-refundable general business tax credit. This credit lets eligible employers offset their federal income tax liability by the amount that their employees pay out of their tips for Social Security and Medicare taxes. (That rate is currently 7.65%.)
Employers of tipped employees had been worried that the new No Tax on Tips bill would eliminate the FICA credit. However, the National Restaurant Association lobbied aggressively and successfully to keep this credit in place. The FICA credit will remain unchanged even as the No Tax on Tips bill goes into effect.
Other Tax Rules That Won’t Change
There are a few other rules and conditions that will continue to apply to restaurant operators and employees even as the No Tax on Tips rule takes effect.
Payroll Taxes
The new deduction is strictly a federal income tax deduction. This is not an exemption from taxes on Social Security and Medicare. Employees and employers will continue to pay their FICA taxes, according to H&R Block.
State and Local Taxes
The tip deduction applies only to federal income tax. Your state may have its own rules. Employers and employees should speak with their own local tax advisors to make sure they understand how the rules apply in their state and municipality.
Tip Reporting Rules
As always, employees are still required to report tips over $20 per month to their employer by the 10th of the following month.
Step by Step Tips for Getting Your Restaurant Ready
Make sure you’re restaurant is prepared to handle the new tip deduction rules by taking the following steps:
- Review your payroll systems. Confirm your payroll provider can track and report tip income by employee and by occupation. Verify that withholding calculations account for the new deduction threshold.
- Classify positions accurately. Employees need to be in occupations that "customarily and regularly receive tips" as designated by the IRS. Ensure your job classifications match the official occupation list.
- Audit your tip pool policies. Confirm managers and supervisors aren't participating in tip pools. Only tips from compliant arrangements qualify for the deduction.
- Review your auto-gratuity practices. If you use mandatory service charges for large parties, now may be the time to rethink this policy in light of the new tax rules. (SeeA Closer Look at Auto-Gratuities above.)
- Clean up your tip reporting. If you've been passing service fees to employees as tips, now is the time to correct that. Employees won't get the tax benefit unless tips are properly categorized and run through payroll correctly. (See Tips That Do Not Qualify above.)
- Communicate with your team. Many employees won't be aware of this change until they file their 2025 taxes. Make sure you take the time to educate your employees both at the shift level and during recruitment and onboarding procedures.
- Encourage daily tip logging. Recommend that employees keep a personal tip log to ensure accurate reporting so that they can claim the full deduction to which they are entitled.
- Emphasize proper tip reporting. Only tips reported to employers and included on W-2s are eligible for this new deduction.
Handle the New Tax Rules with the Right Tools
The No Tax on Tips provision could provide a major earnings boost to restaurant workers at no extra cost to employers. This, in turn, could help restaurants recruit and retain high-quality employees. Restaurant workers and owners should both benefit from the new rule for as long as it remains in effect.
“But,” Nick cautions, “restaurant owners and operators do face some practical challenges as these changes take effect. It is your responsibility to report tips accurately, comply with tip pool policies, and stay informed as implementation guidance continues to develop.”
Again, we are not tax experts. The information in this article is for informational purposes only. For actual tax advice, we strongly recommend speaking with a tax professional. However, we are restaurant technology experts, and we’re very happy to recommend some of the best payroll and HR tools on the market to help you navigate these changes.
To learn more, reach out today and schedule your free, personalized consultation.
Curious about how much your employees will save with the new no taxes on tips rule? Crunch the numbers using the Tip Tax Savings Calculator below:
