No Tax on Tips and Overtime Provisions Prompt Important Questions and Considerations for Both Employers and Workers
"No Tax on Tips"
What is the new deduction? Chapter 2, Section 70201 establishes a deduction of up to $25,000 for "qualified tip income," which begins to phase out for individuals whose modified adjusted gross income exceeds $150,000 ($300,000 for joint filers).
Which workers can take advantage of the deduction? "Qualified tips" are defined in the OBBBA as "cash tips received by an individual in an occupation which customarily and regularly received tips on or before December 31, 2024, as provided by the Secretary [of the Treasury]." So, this deduction is available to anyone who is "in an occupation which customarily and regularly receive[s] tips."
By October 2, 2025, the IRS must publish a list of occupations that fall into this category.
What tip income can a worker deduct? "Cash tips" include not only tips received from customers that are paid in cash or charged to customers, but also tips received under a tip-sharing arrangement (commonly referred to as a "tip pool"). Further, consistent with FLSA regulations, the OBBBA excludes from its definition of "qualified tips" any mandatory service charges or "automatic gratuities" added to a bill by the business or service provider and paid to employees.
It is important to remember, however, that in most states, employees will still be required to pay state income taxes on their tips under applicable state law.
What are the new reporting requirements for employers under the OBBBA's tip deduction provision? Employers furnishing a Form W-2 to employees or a Form 1099 to independent contractors will be required to provide "a separate accounting of amounts reasonably designated as cash tips" and state the worker's occupation so that the IRS may determine whether he or she is eligible for the tip deduction. Consistent with applicable law, and as a matter of best practice, employers should already be tracking the amount of tips a tipped employee receives. But given that covered employees can now deduct such income on their federal tax filings, accurate accounting and record keeping will be even more important.
Moreover, employers should be cognizant of employees who may perform dual jobs - e.g., when one is a covered tipped position but the other is not.
This document is designed for general information only. The information presented in this document should not be construed to be formal legal or tax advice nor the formation of a lawyer/client relationship.
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