How the “No Tax on Tips” Provision Works – And What You Need to Know

If you or someone you know works in the service industry—restaurants, salons, hospitality, delivery services—you’ve probably heard about the proposed “No Tax on Tips” provision. This has been getting a lot of attention because it could directly affect the way tipped workers take home their income. While the details are still being shaped by lawmakers, here’s what you need to know about how this provision would work and what it could mean for both workers and businesses.

What Is the “No Tax on Tips” Provision?

Currently, tips are considered taxable income. Employees who receive tips are required to report them to their employer, who then withholds federal income tax, Social Security, and Medicare from those earnings—just like with hourly wages.

The “No Tax on Tips” proposal aims to exclude tips from federal income tax. This means:

• Tipped workers would no longer owe federal income tax on their reported tips.

• Employers would still track tips for wage reporting purposes, but those amounts would not be subject to federal withholding.

• State and local tax rules may still apply unless those governments also choose to adopt similar exemptions.

Why This Matters

For many tipped workers, tips can make up the majority of their income. Under the current tax rules, a significant portion of those tips is withheld, reducing take-home pay. Removing federal taxes on tips could:

• Increase take-home pay for service industry workers.

• Simplify tax filings, since tips wouldn’t need to be reported as taxable wages on federal returns.

• Encourage accurate tip reporting, since employees may be less likely to underreport if taxes aren’t owed on them.

Key Points to Understand

1. It's a Temporary Deduction

This deduction is effective for 2025 through 2028. The maximum annual deduction is $25,000, with a deduction phase out for taxpayers with modified adjusted gross income over $150,000 ($300,000 for joint filers).

2. Payroll Withholding Would Change

Employers would need to adjust payroll systems so tips are excluded from federal withholding. This could mean updates to payroll software, reporting practices, and compliance procedures.

3. Social Security & Medicare Could Still Apply

One key question lawmakers are still addressing is whether tips will remain subject to FICA taxes (Social Security and Medicare). If they are excluded from all payroll taxes, it could affect workers’ future Social Security earnings.

4. State Taxes May Differ

Even if tips are exempt from federal income tax, states and localities may still require them to be reported and taxed unless they adopt similar rules. Workers will need to check their state’s position once the law is finalized.

5. Employers Must Stay Compliant

Businesses in the service industry will need to carefully update their payroll systems to ensure compliance and avoid penalties. Employers should keep an eye out for IRS guidance if this law passes.

What You Should Do Now

• Stay Informed. Keep up with IRS announcements and news coverage as the legislation progresses.

• Continue Reporting Tips. Until the law officially changes, tips are still fully taxable under current rules.

• Plan for Take-Home Changes. If you’re a tipped worker, be prepared for your net pay to increase once this law is implemented.

• Talk to a CPA. Tax rules can be complex, especially with federal and state differences. A professional can help you understand how this will impact your specific situation.

Final Thoughts

The “No Tax on Tips” provision could significantly change the financial picture for millions of service industry workers by boosting take-home pay and reducing tax burdens. But as with all tax laws, the details matter—and those details are still being worked out.

As a CPA with over 25 years of experience, my advice is simple: don’t change your reporting habits until the law is official, and be ready to adjust once final rules are published. Staying proactive and informed will help you take advantage of any benefits when they arrive.

About the Author

Cherie Sayban is a certified public accountant. She has over 25+ years of experience in Finance, Accounting and Bookkeeping.  

​Cherie Sayban CPA provides various financial and accounting solutions to small and mid-size businesses. Our portfolio includes: tax preparation, payroll preparation, accounts receivable and payables, general ledger, and QuickBooks . Our bookkeeping workshops are offered both in-person and virtually.

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