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The One Big Beautiful Bill introduced a tax deduction allowing employees in certain occupations to deduct qualified tip earnings from federal income tax.
While the rule increases take-home income for tipped workers, it also introduces new payroll reporting requirements for employers. Netchex payroll software helps businesses prepare for the new 2026 tip reporting requirements.
What Changed with Tip Tax Deductions
Key rules under the legislation:
- Only voluntary tips qualify for the tax deduction
- Service charges and automatic gratuities do not qualify
- The deduction applies only to federal income tax
- Paychecks do not change immediately
- Employees claim the deduction when filing their tax return
2025 Transition Guidance
The IRS provided transition relief for the 2025 tax year. Employers are encouraged to provide a reasonable estimate of qualified tips,
but W-2 changes are not required for 2025. Employees may estimate qualified tips using:
- W-2 Box 7
- W-2 Box 8
- Personal tip logs
2026 Tip Reporting Requirements
Beginning in 2026, employers must follow updated payroll reporting
requirements. These include:
- Reporting qualified tips in Box 12 Code TP
- Reporting Treasury Tipped Occupation Codes in Box 14b
- Separating voluntary tips from service charges in payroll
FAQs
No. Tip earnings will still be taxed normally in the paycheck. Employees receive the benefit when they deduct qualified tip earnings on their tax return.
Only voluntary tips qualify. Service charges and automatic gratuities do not qualify.
A service charge or automatic gratuity is a mandatory amount added to a customer’s bill by the employer, such as a large party gratuity or hotel room service charge.
Netchex will create a Service Charges earnings code so tips and service charges can be tracked separately.
No. The IRS provided transition relief for 2025 because the legislation was passed mid-year.
Taxpayers can deduct up to $25,000 in qualified tips per tax return.
Yes. Phase-out begins at $150,000 MAGI for single filers and $300,000 for married filing jointly.
No. Payroll taxes remain unchanged. Only federal income tax allows the deduction.
The deduction is an above-the-line deduction and does not affect standard or itemized deductions.
No. Only employees working in IRS-approved tipped occupations qualify.
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