The One Big Beautiful Bill Act (OBBBA) introduces several significant changes for employers, including new federal income tax deductions for qualified tips, effective for tax years 2025 through 2028. Some of these provisions are retroactively effective as of January 1, 2025, impacting tax reporting. The OBBBA builds upon and modifies elements of the 2017 Tax Cuts and Jobs Act (TCJA), many of which were set to expire at the end of 2025.
Important Considerations
While these deductions offer potential tax savings, there are two important considerations:
- Detailed qualifications: The deductions come with specific eligibility requirements.
- Delayed impact: The benefits will primarily be realized when filing annual tax returns, rather than through immediate payroll adjustments.
Definition of Qualified Tips
- Eligibility: To claim the deduction, a worker must be in an occupation on the list of qualified occupations and receive qualified tips. The proposed regulations provide a definition of qualified and non-qualified tips, which includes the factors below.
Qualified tips must be:
- Paid in cash or an equivalent medium, such as check, credit card, debit card, gift card, tangible or intangible tokens that are readily exchangeable for a fixed amount in cash or another form of electronic settlement or mobile payment application (excluding most digital assets) denominated in cash.
- Received from customers or, in the case of an employee, through a mandatory or voluntary tip-sharing arrangement, such as a tip pool.
- Paid voluntarily by the customer and not be subject to negotiation.
Qualified tips do not include some service charges. For instance, if a restaurant imposes an automatic 18% service charge for large parties and distributes that amount to waiters, bussers and kitchen staff, if the charge is added with no option for the customer to disregard or modify it, the amounts distributed to the workers are not qualified tips.
Any amount received for illegal activity, prostitution services, or pornographic activity is not a qualified tip.
Deduction Limits
- Cap: The deduction is limited to $25,000 of qualified tips.
- Phase-out: Both the overtime and tips deductions phase out completely for taxpayers with a modified adjusted gross income exceeding:
- $150,000 for single filers.
- $300,000 for married taxpayers filing jointly.
Employer Obligations and Reporting Changes
To ensure compliance with the OBBBA, employers will need to adapt their payroll reporting processes:
Revised Form W-2
- Transition period: The IRS is expected to issue transitional guidance for 2025, with major changes anticipated for the 2026 tax year.
- New codes: Drafts of the revised Form W-2 for 2026 include new codes in Box 12 to report:
- Qualified tips.
- Contributions to Trump Accounts (a new savings vehicle introduced by the OBBBA).
- Occupation reporting: Employers must use a treasury code to specify the nature of an employee’s occupation as it relates to qualified tips. This will be reported in Box 14 of the W-2.
The IRS will provide detailed instructions to employers on how to report qualified wages and tips. Employers should monitor updates closely to ensure compliance.
Contact your RKL advisor today to discuss these new provisions and how they may affect your business.
