What Is the No Tax on Tips Act?
The No Tax on Tips Act is a significant piece of tax legislation that recently passed unanimously in the Senate and is now headed to the House of Representatives. If enacted, this bill would create a federal income tax deduction of up to $25,000 annually for qualified tips received by eligible employees. The legislation represents a major shift in how tip income is treated in the U.S. tax code and has garnered bipartisan support since it was first proposed during the 2024 presidential campaign.
Key Provisions of the Legislation
According to the current version of the bill (H.R.482/S.129), the main components include:
- A deduction for “qualified tips” of up to $25,000 per year for eligible employees
- A limitation that restricts the deduction to employees who earned less than $160,000 in the previous tax year (adjusted annually for inflation)
- A requirement that tips must be received during employment in occupations that “traditionally and customarily” receive tips
- Tips must be reported to employers for purposes of withholding payroll taxes
- The Treasury Department would be required to publish a list of traditional tip-receiving occupations within 90 days of the bill’s enactment
- The bill expands the business tax credit for employers’ payroll taxes paid on certain tips to include those paid in connection with barbering, hair care, nail care, esthetics, and body and spa treatments
Importantly, the deduction applies only to cash tips, which includes those paid by cash, credit card, or debit card. These tips must be paid voluntarily, without consequence for nonpayment, and cannot be subject to negotiation.
Who Will Be Impacted?
The No Tax on Tips Act would primarily affect workers in service industries who rely on tips as a significant portion of their income. This includes:
- Restaurant servers and bartenders
- Hotel staff and hospitality workers
- Taxi and rideshare drivers
- Hairstylists and barbers
- Nail technicians and estheticians
- Delivery drivers
- Other service industry professionals who regularly receive tips
According to industry data, approximately 4 million workers in the United States are employed in traditionally tipped occupations. In states with large tourism sectors like Florida, which ranks as the third-highest tipping state with average tips of 21.68%, the impact could be particularly significant.
Potential Benefits for Workers
For eligible workers, the tax deduction could provide meaningful financial relief. Take the example of a restaurant server earning $40,000 annually, with $35,000 in wages and $5,000 in tips. Under the current law, all $40,000 would be subject to federal income tax. With the No Tax on Tips Act, the $5,000 in tips would be deductible, reducing taxable income to $35,000 and potentially providing a tax savings of approximately $600, depending on their tax bracket.
For workers in states that conform to federal tax treatment, there could be additional savings on state income taxes as well. This tax relief might be especially valuable for service industry workers who faced significant economic challenges during recent economic disruptions.
Limitations and Considerations
While the bill offers potential benefits, there are important limitations and considerations to note:
- Income threshold: Only workers who earned less than $160,000 in the previous tax year would qualify for the deduction.
- Reporting requirements: To claim the deduction, tips must be reported to employers for payroll tax purposes. Currently, employees are required to report tips exceeding $20 per month.
- Payroll taxes still apply: The bill creates a deduction for federal income tax but does not eliminate payroll taxes (Social Security and Medicare) on tips.
- Revenue impact: The legislation is estimated to cost the federal government between $10-15 billion annually in lost revenue, according to the Committee for a Responsible Federal Budget.
- State conformity questions: States will need to decide whether to conform to or decouple from the federal policy change, potentially creating a patchwork of rules across the country.
What CPAs Need to Know
For accounting professionals advising clients, several important considerations emerge:
Reporting and Compliance Concerns
The IRS estimates that tips are underreported by tens of billions of dollars annually. This legislation may create new compliance challenges, as the financial incentive to report tips may be offset by the desire to classify more forms of income as “tips” to qualify for the deduction. CPAs should be prepared to:
- Guide clients on proper classification of wages versus tips
- Understand and explain the documentation requirements for claiming the deduction
- Help employers implement or update tip reporting systems
- Advise on potential audit risk factors related to tip income
State Tax Implications
CPAs will need to monitor state responses to the federal change. Nearly a dozen states have already introduced similar proposals at the state level for the 2025 legislative session, including Arizona, Kentucky, Kansas, Maryland, Nebraska, New Jersey, New York, North Carolina, Oregon, South Carolina, and Virginia. However, none have passed as of this writing.
State conformity decisions will have significant implications for tax preparation, potentially increasing complexity if states take different approaches to tip income taxation.
Planning Opportunities
The legislation creates new tax planning opportunities for eligible clients:
- For service industry businesses, reviewing compensation structures to ensure proper classification of tip income
- For individual taxpayers, ensuring proper documentation and reporting of tip income
- For businesses expanding the range of services that may qualify for the employer tip credit, such as spas and salons
Systems and Software Updates
Tax preparation software will need updates to accommodate the new deduction. CPAs should:
- Ensure their systems are prepared for the changes
- Update client questionnaires to capture information about tip income
- Develop client education materials about the new rules
Implementation Timeline
If the bill passes the House and is signed into law, the Treasury Department would have 90 days to publish a list of occupations that traditionally receive tips and would be eligible for the deduction. This rapid implementation timeline means CPAs need to prepare quickly for the changes.
The Broader Debate
While the No Tax on Tips Act has received bipartisan support, economic policy experts remain divided on its merits. Proponents argue it provides targeted relief to service industry workers, many of whom rely heavily on tips and often earn modest incomes. The National Restaurant Association has endorsed the bill, stating it would “put cash back in the pocket of a significant number of workers” and “help restaurant operators recruit industry workforce.”
Critics, however, contend that the tax benefit is poorly targeted, potentially regressive, and could have unintended consequences for labor markets and tax compliance. Some analysts suggest that many low-income tipped workers already pay little or no federal income tax due to existing deductions and credits, meaning the benefit would primarily aid higher-earning tipped workers.
Additionally, some economists express concern that exempting tips from taxation could reduce pressure on employers to raise base wages, potentially allowing them to effectively capture a portion of the tax benefit.
Conclusion
The No Tax on Tips Act represents a significant potential change to the U.S. tax code that would affect millions of workers and businesses in the service industry. For CPAs and tax professionals, staying informed about the legislation’s progress and preparing for its implementation will be crucial in the coming months.
If passed, the tax deduction for tips would create both opportunities and challenges for tax planning and compliance. While the immediate impact would be a tax reduction for many service industry workers, the long-term effects on labor markets, tax compliance, and government revenue remain subjects of debate among policy experts.
As with any major tax change, CPAs will play a vital role in helping clients navigate the new rules and optimize their tax positions within the bounds of the law.
The provisions in this Act are also largely contained in the broader “One Big Beautiful Bill” reconciliation package, an expansive legislative proposal aiming to extend TCJA tax cuts and introduce new tax relief measures. Please continue to monitor legislative activity through eventual passage.