No Tax on Tips for 2025: What the “Transition Year” Really Means for QSR Operators

The new “No Tax on Tips” rule sounds straightforward. Tips aren’t taxed. Done, right?

Not quite.

The law is retroactive to January 1, 2025, but the IRS has officially labeled 2025 a transition year. That means the deduction exists, but the reporting systems to support it don’t fully exist yet. For restaurants and QSR operators, that creates both opportunity and risk heading into 2026 filing season.

Here’s what you need to know.

What the No Tax on Tips deduction actually is

The One Big Beautiful Bill Act, signed July 4, 2025, created a new federal income tax deduction for qualified tips under IRC §224. It applies to tax years 2025 through 2028.

Eligible workers can deduct up to $25,000 per year in qualified tips, whether they itemize or take the standard deduction. The benefit phases out when modified AGI exceeds $150,000 for single filers or $300,000 for joint filers. Both employees and independent contractors may qualify, although self-employed individuals generally can’t deduct more than their net income from the business where the tips were earned.

What’s critical for operators to understand is what the deduction is not. Tips are still wages for payroll tax and withholding purposes. This is an income tax deduction, not a change to payroll rules.

Not all “tips” qualify

Calling something a tip doesn’t make it a qualified tip.

To qualify, tips must be voluntary, determined by the customer, and not negotiated or mandatory. They must be paid as cash tips, which includes tips paid by credit or debit card and tips received through tip pools. And they must be earned in an occupation the IRS considers customarily and regularly tipped.

Mandatory service charges or automatic gratuities generally do not qualify, even if the money is later paid out to employees. The only real exception is when the customer can clearly modify or remove the amount without consequence. Many QSR service charges won’t meet that standard.

The biggest catch: the tips must be reported

The deduction only applies to tips that are reported to the IRS.

For employees, that means tips reported through the normal channels: W-2 reporting, Form 4070 tip reports to employers, or Form 4137 for unreported tips. For nonemployees, it means documentation tied to income reporting, even though 2025 forms won’t break tips out cleanly.

This is where many people will get tripped up. A tip that isn’t documented and reported doesn’t qualify for the deduction.

Why 2025 is different

For 2025, the IRS has confirmed there will be no changes to Forms W-2, 1099-NEC, 1099-MISC, or 1099-K to add special tip reporting fields. Those updates are expected for 2026.

As a result, employers are not required to separately report qualified tips on 2025 forms. Employees and contractors will often have to calculate their own qualified tip totals using available records.

In plain terms, documentation matters more than ever in 2025.

How employees will determine qualified tips

For employees, the IRS allows qualified tips for 2025 to be determined using several practical sources. These include W-2 Box 7 (Social Security tips), tips reported to the employer on Form 4070 or equivalent reports, separate tip totals provided by the employer, and tips reported on Form 4137.

One common issue is that W-2 Box 7 may understate tips if the employee hit the Social Security wage base. In those cases, Form 4070 reports or employer-provided summaries may be more accurate.

Independent contractors face heavier documentation

Independent contractors have more flexibility in 2025, but also more responsibility.

Because 1099s won’t separately identify tips for 2025, the IRS allows nonemployees to support qualified tips using earnings statements, POS reports, daily tip logs, receipts, and payment processor records. This is especially important for cash tips, which won’t be cleanly reflected on information returns.

Good records will be the difference between a valid deduction and a denied one.

The SSTB restriction exists, but enforcement is delayed

The law generally disallows the deduction for tips earned in Specified Service Trades or Businesses, like law, accounting, consulting, or financial services.

However, the IRS has announced transition relief. Until final regulations take effect, the SSTB limitation won’t be enforced for tipped employees, and similar relief applies to nonemployees.

For 2025, eligibility, voluntariness of tips, and documentation are far more important than SSTB classification for most QSR-related roles.

What QSR operators should do now

If your stores accept tips — counter service, curbside, delivery, or pooled tips — the goal for 2025 is clarity.

Make sure your POS and payroll systems capture tip data in a way that can be summarized at year-end. Encourage employees to submit regular tip reports and keep their own records. Even though it’s not required, providing a clear year-end tip summary can significantly reduce confusion and tax-season friction.

If you use service charges or automatic gratuities, review them carefully. Many won’t qualify as tips for this deduction, which can lead to employee confusion if expectations aren’t managed early.

Bottom line

The No Tax on Tips deduction is real for 2025, but it’s not automatic.

Employees and contractors who benefit will be the ones who can clearly show they worked in an eligible tipped occupation, received voluntary tips rather than service charges, and can document and support the total using available records.

For operators, clean systems and proactive communication now can prevent a messy W-2 season later.

If you want help tightening up tip reporting workflows or preparing for the 2026 reporting changes, Finatech can help you get ahead of it.