IRS Publishes Final Rules on Qualified Tip Deduction

Under the One Big Beautiful Bill Act (OBBBA), for tax years 2025-2028, eligible individuals can claim deductions for qualified tips. The IRS recently issued final regulations that clarify what occupations and which payments are eligible for the deduction. The regulations introduce broad anti-abuse rules intended to prevent employers and employees from recharacterizing other compensation as tips for purposes of claiming the tax deduction.

OBBBA Qualified Tip Tax Deduction and 2025 Guidance

As discussed in our December 2025 alert, eligible employees and self-employed individuals may deduct up to $25,000 of qualified tips, subject to a phaseout for individuals with modified adjusted gross income over specified thresholds. Qualified tips are cash amounts received by an individual who works in an occupation that customarily and regularly received tips before 2025, but exclude amounts that are not paid voluntarily or are paid to someone working for an employer engaged in a "specified service trade or business" (including health, law, performing arts, and financial services).

Under the OBBBA, employers and other service recipients are required to separately report the amount of cash tips paid to an individual and to identify the individual's occupation on Forms W-2 and 1099. In 2025, the IRS published a list of occupations customarily and regularly involving tips, including food and beverage, entertainment, hospitality, transportation, and personal services.

However, the Forms W-2 and 1099 were not updated for 2025 tax reporting, and the IRS issued transition relief for 2025 tip income:

• Employers or other payors are not subject to penalties if they did not report cash tip income or include occupation codes on information returns filed and furnished with respect to 2025.
• Individuals in occupations customarily and regularly receiving tips before 2025 were permitted to claim the deduction for qualified tips, as long as the tips were included in the total amount of wages or other compensation reported on Form W-2 or 1099 (even if these amounts were not separately accounted for) and the amount deducted was calculated under one of several designated methods.
• The rules on specified service trades or businesses were suspended pending further guidance, such that individuals who received cash tips that otherwise qualified as qualified tips could claim the deduction, even if their employer was in a specified trade or business.

New Requirements for 2026 Qualified Tip Deduction

The IRS has now released updated Forms W-2 and 1099 (draft) for 2026 and issued final regulations for qualified tips. Beginning with amounts earned in 2026, employers must report on Form W-2 both (1) cash tip amounts in Box 12 with code "TP," and (2) the employee's Treasury Tipped Occupation Code(s) in new Box 14b. (Employees may also separately report tip income on Form 4137). Individuals will not be eligible to claim a tax deduction for any tip income that is not correctly reported or does not meet the conditions for qualified tips.

The final regulations cover the following:

• Exhaustive list of eligible occupations (with a non-exhaustive list of illustrative examples): The list of occupations that receive tips is sorted into eight categories based on industry or job type. Only tips that are received in one of the listed occupations (regardless of whether the specific job is included as an illustrative example) are eligible for the tax deduction. Employers should consult the list to determine the appropriate Treasury Tipped Occupation Code for each employee that has received cash tips.
  • This reporting may be complicated if an employee can receive tips for performing multiple roles. For example, if a restaurant manager receives a customer tip for satisfactorily resolving a diner's complaint, this payment is not a qualified tip because restaurant manager is not a listed occupation. However, if the manager also occasionally performs waitstaff duties, then any tips received while performing such duties would be a qualified tip.
• Guidance on specified service trade or business exclusion reserved: The final regulations do not address the specified service trade or business exclusion, and such guidance is reserved. This means that, until further guidance is issued, individuals may continue to claim the tax deduction for cash tips that otherwise satisfy the requirements for qualified tips, even if their employer is in a specified trade or business.
• Clarification of cash tips: Qualified tips include only amounts that are paid or denominated in cash (or are easily exchangeable for a fixed amount of cash), including checks, credit cards, gift cards, mobile payment apps settled in cash, and foreign currency. The regulations exclude the value of tips that are paid in any non-cash medium, including digital assets (such as cryptocurrencies and stablecoins), event tickets, meals, or services.
• Confirmation that tips must be voluntary: Qualified tips only include amounts that are voluntarily paid, where the customer has the ability to negotiate the full tip amount. Tips received from a tip pool or through a tip-sharing arrangement are eligible, but mandatory service charges and automatic gratuities are ineligible.
  • If a bill includes both a mandatory charge and an "additional tip amount" line, only the customer-added amount on the additional tip amount line can be a qualified tip.
  • For tips paid through a point-of-sale (POS) device, the full tip amount can be a qualified tip only if the POS device offers a "no tip" (zero) option. If the device does not offer a "no tip" option, only the amount in excess of the lowest required tip amount or percentage can be a qualified tip.
• Broad anti-abuse rule adopted: An amount is not a qualified tip if, based on all relevant facts and circumstances, it represents a recharacterization of wages or other compensation as tips.
  • An irrebuttable presumption of recharacterization applies where either the employer is the payor of the tip, or the tip recipient owns at least 5% of the payor entity.
  • Employers should not restructure compensation arrangements to reclassify wages or guaranteed compensation as tips for purposes of allowing employees to claim the qualified tip tax deduction.

Action Steps for Employers

• Employers should continue to work with their payroll providers to track and separately report cash tip compensation starting in 2026. These actions include updating payroll recordkeeping systems to identify employees who receive cash tips, their Treasury Tipped Occupation Codes, and whether tips were received while the employee was performing duties in an eligible occupation code.
• Employers who use automatic service charges or POS systems without a zero-tip option should review their policies to determine whether changes, including ensuring POS systems offer a "no tip" option, may be necessary to maximize the qualified tip deduction available to their employees.

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Amy Hwang advises companies across various industries on compensation and employee benefits matters within DWT's employment group. Pamela Charles chairs the tax practice within DWT's corporate & business transactions practice group. For any questions or more insights, please reach out to either of the authors and sign up for our alerts.