By: Cody J. Townsend
The One Big Beautiful Bill Act (OBBBA), signed into law in 2025, includes a number of tax changes designed to benefit working Americans, and our Dillon, MT contract lawyers are here to help you understand the implications of this bill. Among the most discussed is the so-called “No Tax on Tips” provision, codified in Section 224 of the Internal Revenue Code. The name can be misleading. Tips are not completely tax-free. Instead, certain employees can claim a new deduction on their federal income tax for qualifying tip income. This reduces taxable income without eliminating it entirely.
The provision targets employees in occupations that have historically relied on tips as a substantial part of their earnings, such as servers, bartenders, and other roles in the hospitality industry. The goal is to provide these workers with a meaningful income tax benefit while maintaining existing payroll and wage reporting requirements.
How The Deduction Works
Employees in qualifying tipped occupations may deduct up to $25,000 of “qualified tips” from their federal taxable income each year. Qualified tips are voluntary gratuities received directly from customers or through tip-sharing arrangements in occupations where tipping is customary and regular.
Not all tip-like payments qualify. Mandatory service charges or automatic gratuities, such as an 18% charge added for large parties, are considered wages. They do not qualify as tips. Employers must continue to report these payments as wages and withhold applicable payroll taxes.
The deduction applies to federal income tax only. Social Security, Medicare, and other payroll taxes still apply to all tip income. Employees benefit from lower federal tax liability, but employers must continue to follow existing rules for reporting and withholding.
Eligibility And Occupation Limits
The provision is limited to occupations that customarily and regularly receive tips prior to the end of 2024. The Treasury Department has published a preliminary list of eligible occupations. Broadly, the law targets jobs in food service, bars, and certain hospitality roles. Workers in professions outside these categories, including law, finance, or consulting, are generally ineligible, even if they receive occasional gratuities.
The deduction is capped at $25,000 per year. The benefit phases out for higher-income taxpayers. Single filers begin losing the deduction once their modified adjusted gross income (MAGI) exceeds $150,000. Married couples filing jointly face a phase-out starting at $300,000. The deduction is gradually reduced by $100 for each $1,000 of MAGI above the threshold.
Why Mandatory Service Charges Matter
For employers, distinguishing between voluntary tips and mandatory service charges is critical. Voluntary tips may reduce an employee’s income tax liability. Mandatory service charges do not qualify for the deduction. They remain wages and must be reported and taxed accordingly.
Employers may need to update payroll systems and reporting practices to separate voluntary tips from non-qualifying service charges. Clear communication to employees is important to avoid confusion about what constitutes deductible tip income.
Temporary Nature And State Considerations
The “No Tax on Tips” deduction is temporary. It applies to tax years beginning after December 31, 2024, through December 31, 2028. Congress could extend the provision, but as of now it is limited to that period. Employers and employees should note that while this is a federal income tax deduction, state tax treatment may differ. Some states may not conform to the federal provision.
Practical Implications
For tipped employees, the provision offers an opportunity to lower federal income taxes on a significant portion of their earnings. For employers, it emphasizes careful payroll and tip reporting, especially in distinguishing between voluntary tips and mandatory service charges. Businesses may also see benefits in recruiting and retaining tipped employees. The deduction can be viewed as an additional financial incentive for workers.
The OBBBA’s “No Tax on Tips” provision does not make tips tax-free. It provides a targeted income tax deduction for eligible employees, with clear rules about which tips qualify and which do not. Understanding these rules now helps both employees and employers maximize the benefit while remaining compliant.
At Silverman Law Office, our team of trained tax attorneys is here to help employers and employees navigate the ever-changing world of tax. Contact us at 406-582-8822 or https://mttaxlaw.com/contact/ to discuss how the “No Tax on Tips” provision may affect your business or personal tax situation.
Cody J. Townsend is an associate attorney at Silverman Law Office.