A significant change is on the horizon for businesses with tipped employees. The new “no tax on tips” deduction, originating from the One Big Beautiful Bill Act (OBBB), introduces a major shift in how tip income is treated for tax purposes. If you’re a small business owner in an industry like hospitality, personal care, or transportation, you’ll need to understand this new rule.
This article offers a clear breakdown of the “no tax on tips” deduction explained for business owners. We’ll cover who’s eligible, what payments qualify, and how your business can prepare for this change.
Jump to:
What is the “no tax on tips” deduction?
The “no tax on tips” deduction is a new provision that allows certain employees in tipped occupations to deduct up to $25,000 of their tip income from their federal income taxes. The deduction was established by the One Big Beautiful Bill Act and is set to be in effect through 2028. This temporary measure provides significant tax relief to millions of workers in service-based industries.
For small business owners, this change has several implications. While the tax benefit goes directly to the employee, it affects payroll, tax reporting, and even employee compensation strategies.
Who is eligible for the deduction?
Eligibility for the deduction depends on both the employee’s occupation and, in some cases, the type of business they work for. The IRS and Treasury Department have released a detailed list of eligible occupations.
Eligible Occupations
The government identified 68 occupations that “customarily and regularly received tips” on or before Dec. 31, 2024. This list was created using tax data, congressional guidance, and labor laws. Some of the most common eligible occupations include:
- Waitstaff
- Bartenders
- Hairstylists and barbers
- Massage therapists
- Home movers
If your employees work in one of these roles, they’re likely eligible to claim the deduction. It’s a good practice to review the full list to see which of your team members may qualify.
The SSTB Exception
A key limitation is the specified service trade or business (SSTB) rule. This rule, borrowed from another section of the tax code, can make an otherwise eligible worker ineligible for the deduction. An SSTB is a business in fields like health, law, consulting, athletics, financial services, or the performing arts.
Here’s how it works:
- An employee (like a bartender) working for a non-SSTB business (like a restaurant) is eligible.
- An employee working for an SSTB (like a comedian performing at a venue) is generally not eligible.
- A self-employed individual in an SSTB field also cannot claim the deduction.
Business owners, especially those operating C corporations not previously affected by SSTB rules, will need to determine if their business falls into this category to correctly advise employees.
What payments qualify as tips?
The IRS has provided specific guidance on what constitutes a “qualified tip” eligible for the deduction. Understanding this is vital for accurate payroll and reporting.
Eligible Payments
- Cash: Physical currency given directly to the employee.
- Credit, debit, and gift cards: Tips added to electronic payments.
- Mobile payments: Tips received through apps like Venmo or PayPal, as long as they’re settled in cash.
- Certain tokens: Items like casino chips that are exchangeable for a fixed cash amount.
These payments are considered voluntary gratuities from a customer to an employee.
Ineligible Payments
- Automatic gratuities: Mandatory charges added to a bill, such as an 18% service charge for large parties, are not considered tips. We’ll explore this more below.
- Service charges: Any other mandatory fee added by the establishment.
- Non-cash assets: Tips paid in the form of meals, services, event tickets, or most digital assets like cryptocurrency.
Your point-of-sale and payroll systems must be able to distinguish between qualified tips and these other forms of payment.
Is there a limit on how much is deductible?
The deduction is capped at $25,000 per tax return, per year. This limit applies regardless of the taxpayer’s filing status. This means a married couple filing a joint return can only deduct a combined total of $25,000, even if both spouses have eligible tip income.
For business owners, this cap is an important detail to communicate to your employees. High-earning tipped employees, such as those in fine dining or popular entertainment venues, may earn more than $25,000 in tips annually. They need to understand that only the first $25,000 of their reported tip income is deductible. This detail helps manage their expectations about the tax benefit they’ll receive.
Are automatic gratuities eligible for the deduction?
The rules around automatic gratuities are a critical point for many service businesses. The IRS has stated that mandatory charges are not eligible for the deduction. However, there is a key exception.
An automatic gratuity or service charge can be considered a qualified tip if the customer is “expressly provided an option to disregard or modify it without consequence.”
This means you could implement a policy where:
- A default gratuity (e.g., 20%) is suggested for large parties.
- Your staff clearly informs the customer that this amount is optional and can be changed or removed.
If you choose this path, it’s essential to train your staff to communicate this option clearly and to document your policy. Without this explicit customer choice, any automatic gratuity will be considered a service charge and will not be eligible for the deduction.
What should small business owners do next?
With the deduction taking effect in 2025 for the 2026 tax filing season, now is the time to prepare. Some steps you can take:
- Review your staff roster. Identify which employees work in occupations eligible for the deduction.
- Update your payroll system. Ensure your system can accurately track and separate qualified tips from wages and ineligible service charges.
- Train your employees. Educate your team about the new deduction, including eligibility, qualifying payments, and the $25,000 cap. Proper tip reporting by employees is more important than ever.
- Re-evaluate your gratuity policies. If you use automatic gratuities, decide whether to adjust your policy to meet the IRS criteria for voluntary payments.
- Consult a tax professional. Work with your accountant to understand how these changes impact your specific business and to ensure full compliance. Having the deduction explained by an expert can save you from costly mistakes.
The “no tax on tips” deduction represents a valuable benefit for employees and a significant operational shift for small businesses. By learning the rules and preparing now, you can support your staff in taking full advantage of this new tax break while keeping your business compliant and running smoothly.
