No tax on tips: what it actually is
The name is doing a lot of work. It is a deduction rather than an exclusion, it reduces income tax and not payroll tax, tips still appear as wages on the W-2, staff still report tips to you every month, and your FICA bill did not change. Here is the whole thing, cited to the statute and the IRS notices.
Judd Alsup and the Equip Payment Solutions team, who install and support restaurant POS systems nationwide and sell Shift4 Dine and Clover.Updated August 9, 2026. Sources and dates cited on every figure.
The short answer
No tax on tips, in one box:
- It is a deduction, not an exclusion up to $25,000 a year under IRC 224, added by Public Law 119-21 on 4 July 2025.
- Income tax only it does not reduce Social Security or Medicare tax, for the employee or for you.
- Phases out from $150,000 $300,000 filing jointly, by $100 for every $1,000 of modified AGI above it.
- Tax years 2025 to 2028 IRC 224(h) ends it after 2028.
- Mandatory service charges do not count unless the customer can decline or modify them. A mandatory tip pool is fine.
- New W-2 boxes for 2026 box 12 code TP for cash tips, box 14b for the Treasury Tipped Occupation Code.
The rest of this page is the case for each line, with sources.
The single most misunderstood part, first
It is a deduction, not an exclusion. Tips remain gross income, remain wages, and still appear on the W-2. IRC 224(a), added by the One, Big, Beautiful Bill Act (Public Law 119-21, enacted 4 July 2025), allows a deduction equal to qualified tips received during the year. That is a very different thing from tips not being taxed, and the difference shows up on every paycheque.
It reduces income tax only. It does not reduce Social Security or Medicare tax for the employee, and it does not reduce the employer's share either. The 2026 General Instructions for Forms W-2 and W-3 say it in terms: tips are still generally subject to federal income tax withholding and to both the employer and employee share of social security and Medicare tax where the tips are $20 or more a month. IRS Notice 2025-69 describes section 224 as an income tax deduction. Nothing in it touches Chapter 21.
It is also neither an above the line nor an itemised deduction, which sounds like trivia and is not. Section 224 was added to the list in IRC 63(b), so it is available whether or not the employee itemises. But IRC 62 was not amended, so it does not reduce adjusted gross income. That matters beyond the federal return: states whose income tax starts from federal AGI get no automatic benefit from it and have to legislate their own subtraction. Minnesota's Department of Revenue said exactly that about this provision, noting the federal deduction does not affect AGI and so would not change Minnesota liability without a state subtraction.
The numbers, from the statute
The cap is $25,000 a year
IRC 224(b)(1). Per return, not per job.
The phase-out starts at $150,000, or $300,000 filing jointly
IRC 224(b)(2)(A). It reduces the deduction by $100 for every $1,000 of modified AGI above the threshold, so it is a ten percent taper rather than a cliff. Working the taper out to zero gives $400,000 single and $550,000 joint. That is our arithmetic from the statute, not a figure the IRS publishes.
It runs for tax years 2025 through 2028
Effective for years beginning after 31 December 2024, and IRC 224(h) terminates it for any year beginning after 31 December 2028. Four years, then it is gone unless Congress acts.
A Social Security number is required and joint filers must file jointly
IRC 224(e) and 224(f). Married filing separately is not eligible.
There is no inflation adjustment in the statute
Section 224 as enacted contains no indexing provision for the cap or the thresholds.
Self-employed workers are capped by the business
IRC 224(c) counts qualified tips only to the extent gross income from that trade or business exceeds the deductions allocable to it.
Which occupations qualify, and why back of house is on the list
The deduction applies only to occupations that customarily and regularly received tips on or before 31 December 2024, as determined by the Secretary. Treasury and the IRS published that list in final regulations at Treasury Regulation 1.224-1, effective 12 June 2026, and mirror it at IRS.gov/tippedoccupations. Each entry carries a three digit Treasury Tipped Occupation Code, a description, examples and the related standard occupational classification codes. There are more than seventy of them across eight categories.
For a restaurant the relevant codes are 101 bartenders, 102 wait staff, 103 food or beverage servers outside restaurants, 104 dining room and cafeteria attendants and bartender helpers, 105 chefs and cooks, 106 food preparation workers, 107 fast food and counter workers, 108 dishwashers, 109 host staff, and 110 bakers. Read that list again, because the part that surprises people is real: cooks, prep, dishwashers and bakers are on it. Back of house staff who receive tips through a tip sharing arrangement are in scope, and the statute's definition of cash tips expressly includes tips received under any tip sharing arrangement.
The tip itself has to be voluntary. IRC 224(d)(2)(A) requires that the amount be paid voluntarily, without consequence for nonpayment, not subject to negotiation, and determined by the payer. Cash tips is read broadly and covers tips paid in cash or charged, and the final regulations extend that to cheque, credit card, debit card, gift card and electronic payment denominated in cash, and to tips received through a tip pool whether that pool is mandatory or voluntary.
The automatic gratuity problem, which is a menu decision now
A mandatory service charge is not a qualified tip. The IRS gives the restaurant example itself in the release announcing the final regulations: a restaurant that imposes an automatic eighteen percent service charge on large parties and distributes it to servers, bussers and kitchen staff has not created qualified tips, if the charge is added with no option for the customer to disregard or modify it. The 2026 W-2 instructions repeat it plainly. Mandatory service charges added to the bill are not qualified tips.
Note the asymmetry carefully, because it is the operationally useful part. A mandatory tip pool is fine and its distributions are qualified tips. A mandatory service charge is not, no matter how it is distributed afterward. The thing that disqualifies it is that the customer could not decline or change it.
That turns a long standing policy question into a live one. If your large party gratuity is added automatically with no option to modify, the amounts your staff receive from it are outside the deduction, and your staff will notice at tax time. Making the charge modifiable on request, and configuring the point of sale so a manager can adjust or remove it, changes the answer. We are not going to tell you which way to run your policy, and this is squarely a question for your accountant, but it is now a question with a tax consequence attached and it is worth asking before the next large party season rather than after it.
What changed for the employer, on the forms
Box 12, code TP
Total cash tips reported to the employer. New for tax year 2026, under new IRC 6051(a)(18).
Box 12, code TT
Total qualified overtime compensation, the companion provision. New for the same year.
Box 14 split into 14a and 14b
New box 14b carries the Treasury Tipped Occupation Code, and is used whenever cash tips are reported in box 12 with code TP.
Up to two occupation codes
If an employee received tips in more than two occupations, report any two. If any tips came from a non-qualifying occupation, 000 must be entered as one of the codes.
Box 14b appears on the W-2c as well
Corrections carry the occupation code too.
2026 Forms W-2 are due to the SSA by 1 February 2027
Per the 2026 General Instructions.
The first year was a mess, and the IRS said so
The 2025 forms were never updated for the new provision. The IRS announced in August 2025 that Forms W-2, 1099-NEC, 1099-MISC and 1099-K for 2025 would not change, and then issued Notice 2025-62 granting penalty relief: no penalty under sections 6721 or 6722 for tax year 2025 for failing to separately account for cash tips or to report the occupation code. That relief is conditional. The return still has to be otherwise complete and correct, and the tip amounts still have to be included in the aggregate wage totals. Employers were encouraged but not required to give employees their occupation codes and a separate accounting of cash tips, by box 14, a portal, a written statement or another secure method.
Notice 2025-69 then told individuals how to claim the 2025 deduction without a conforming statement. An employee may use box 7 social security tips on the 2025 W-2, or totals from the Forms 4070 they gave the employer, or an amount the employer voluntarily entered in box 14, plus line 4 of Form 4137. The notice carries a warning worth passing to staff: where boxes 3 and 7 together reach the social security wage base, box 7 may understate actual cash tips, and the worker should check their own Forms 4070.
Anyone who already filed a 2025 return can amend on Form 1040-X to claim it. The deduction is claimed on Schedule 1-A of Form 1040.
What did not change at all
Staff still report tips to you monthly
IRC 6053(a) is untouched. Employees receiving tips that are wages in a calendar month report them in writing to the employer by the tenth of the following month, on Form 4070 or an equivalent.
Tips are still subject to FICA and income tax withholding
Where they are $20 or more a month. The deduction happens on the employee's return, not in your payroll run.
Your employer FICA obligation is the same
Boxes 3, 5 and 7 are unchanged. The new codes are additional boxes, not replacements.
The FICA tip credit survived and grew
IRC 45B still applies, and the Act extended it beyond food and beverage service to barbering and hair care, nail care, esthetics, and body and spa treatments.
Nothing about the Fair Labor Standards Act moved
Notice 2025-69 says so directly. Tip credit, tip pooling and overtime rules under the FLSA are untouched by this. Those are on the tip credit page.
Deductibility still depends on a reporting statement
The tips have to appear on a W-2, 1099-NEC, 1099-MISC, 1099-K, or be self-reported on Form 4137. Notice 2025-62 is explicit that an individual not furnished such a statement cannot claim the deduction.
What this means for your point of sale, which is the part we actually do
The reporting burden this creates lands on data the point of sale already holds and frequently cannot export in the right shape. You now need cash tips reported by employee, separated from charged tips, mapped to an occupation code, for the year. If a server also bartends, you need it by job code, because box 14b takes up to two codes and the code has to be right. If anyone earns tips in a non-qualifying role, that has to be visible too, because the instructions require 000 as one of the codes in that case.
Ask your vendor three questions specifically. Can it report cash tips separately from charged tips by employee for a full year. Can it hold an occupation code against an employee, or against a job code, and export it with the tip totals. And does it export in a shape your payroll provider will accept without somebody retyping it in January. A system that answers no to the third question turns this into several days of manual work every year, and the errors it produces land on your staff's tax returns rather than on the software.
One genuinely unsettled point to watch. The statute excludes tips received in a specified service trade or business under section 199A(d)(2), and treats an employee as being in one if their employer's business is. Notice 2025-69 grants transition relief treating a worker in a listed occupation as not being in such a business, until the first January after final regulations on that question are issued. Those regulations had not been proposed when the notice was written and we could not confirm that they have been since. Do not treat the SSTB question as settled.
This is a reference, not tax advice. We sell point of sale systems, we are not accountants, and the amounts here are large enough to be worth a professional's hour. Every figure above is cited so your accountant can check us rather than take our word for it, and everything was verified against primary sources on 13 August 2026.
Questions owners ask
Are tips actually tax free now?
No. Tips are still gross income, still wages, still on the W-2, and still subject to Social Security and Medicare tax. What exists is a deduction of up to $25,000 a year against income tax, under IRC 224, for tax years 2025 through 2028. The name of the policy is more generous than the policy.
Does this reduce payroll taxes for me or my staff?
No. Section 224 is an income tax deduction. The 2026 W-2 instructions confirm tips remain subject to income tax withholding and both shares of social security and Medicare tax where they are $20 or more a month. Your employer FICA bill is unchanged, and the FICA tip credit under section 45B still applies.
Do kitchen staff qualify?
If they receive tips, yes. The IRS list includes chefs and cooks (105), food preparation workers (106), dishwashers (108) and bakers (110), and the statute counts tips received through a tip sharing arrangement. Back of house being on the list surprises most people.
What about automatic gratuity on large parties?
A mandatory service charge is not a qualified tip. The IRS uses this exact restaurant example: an automatic eighteen percent charge on large parties, distributed to staff, added with no option for the customer to disregard or modify it, does not produce qualified tips. A mandatory tip pool is different and is fine. Worth discussing with your accountant before the next large party season.
What do I have to put on the W-2?
For tax year 2026, box 12 code TP with total cash tips reported to you, and new box 14b with the Treasury Tipped Occupation Code, up to two codes, with 000 as one of them if any tips came from a non-qualifying occupation. 2025 had penalty relief under Notice 2025-62 and the forms were never updated.
Do my staff still have to report tips to me?
Yes. IRC 6053(a) is untouched. Employees report tips in writing by the tenth of the following month, on Form 4070 or an equivalent. Box 12 code TP is literally the total of cash tips reported to the employer, so the monthly reporting is what feeds the new box.
Does my state tax follow the federal deduction?
Generally not automatically. Because the deduction sits under IRC 63(b) rather than 62, it does not reduce federal adjusted gross income, and a state whose tax starts from federal AGI picks up nothing unless it legislates its own subtraction. Minnesota's revenue department said exactly that about this provision. Check your own state.
How long does this last?
Tax years 2025 through 2028. IRC 224(h) terminates it for any tax year beginning after 31 December 2028, and the statute contains no inflation adjustment for the $25,000 cap or the phase-out thresholds.
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