Following the July 4 enactment of the 2025 budget reconciliation act, Treasury and the Internal Revenue Service face an urgent task: clarifying key details Congress left unresolved, especially for the new deduction for tip income. That tax break has been a priority of President Trump, and some taxpayers will be able to deduct gratuities received this year.
But Congress largely punted on three big questions: Who? What? and How?
Answering them adds to the many other responsibilities Treasury and the IRS already face in implementing new tax laws. And employees and their employers will benefit from clarity sooner rather than later.
Who is eligible?
The legislation limits the tax exemption to cash tips received by people in occupations where workers “customarily and regularly” received tips before January 1, 2025.
The reasoning behind that language is clear: Congress wanted to prevent workers and their employers from mischaracterizing wages and salaries as tips. To add teeth to that concern, Treasury is authorized to issue guidance to prevent abuse. Moreover, certain businesses (such as accounting and law firms) are excluded.
But first, Treasury and the IRS must determine a list of qualifying occupations by the beginning of October. Outside of informal sources like advice columns, they have little direction.
Before then-candidate Trump proposed eliminating taxes on tips, confused customers were venting about the new tipping culture or “tipflation.” The confusion is partly fueled by tip jars and tip prompts at self-checkout kiosks. And some frustrated consumers reported expectations for tips coming from unexpected places—such as mortgage companies.
Even within the same business, there’s potential for controversy over the eligibility rules. For example, the statute covers tip-sharing arrangements, so in restaurants, workers other than servers—such as bussers and dishwashers—could benefit if tips are pooled and distributed to all employees. But if the restaurant does not follow that practice, those workers would pay taxes on their total cash compensation, while the servers’ tips would be tax-free.
What income is tax-free?
According to the act, tips are amounts “paid voluntarily without any consequence in the event of nonpayment, is not the subject of negotiation, and is determined by the payor.”
Five words—voluntarily and determined by the payor—may make a big difference in paychecks. Workers might be very disappointed if the IRS relies on the same guidance used for the existing credit for employers’ share of social security taxes paid on tips.
For example, 16 percent of restaurants add a service charge (say 20 percent) to the bill, and 54 percent sometimes do. Because that service charge is mandatory and fixed, those payments are not considered to be a tip.
There’s another wrinkle to the treatment of service fees. While they look like a gratuity, the service fee may also cover part of the owner’s non-labor costs.
But in DC, for example, the service fees are most likely going to the servers’ pockets due to Initiative 82, passed by DC voters in 2022, which gradually increases the minimum wage of restaurant workers to the same level as required for other workers. Currently, employers must pay their tipped workers the difference between the hourly minimum wage for other workers—a combined federal-DC rate of $17.95—and the sum of the lower rate for tipped workers ($10) plus their average hourly tips.
To offset those higher labor costs, many DC restaurants have added a service fee to the bill, often with an explanation that the charge goes entirely to the worker and that tips are not expected but always appreciated.
Unless Treasury and the IRS adopt a different definition of tips for the new deduction, workers in DC restaurants with service fees (and in other communities with similar customs) may not get a tax break.
How will taxes be paid?
Expect changes to the withholding tables in 2026, though many tipped workers and their employers probably will not get it precisely right: Tip income fluctuates throughout the year for various reasons including variability in customers’ generosity as well as, for example, high employee turnover in restaurants.
But 2025 creates a much larger headache for workers. More than halfway through the tax year, they still don’t know “who” is eligible or “what” income counts—and the IRS is not obligated to amend 2025 withholding tables. However, the IRS must specify reporting requirements on 2025 W-2s before the end of this year.
Eligible taxpayers may not care if the result is large refunds next spring. But without clarity on “who” and “what” before January 1, many taxpayers may be very confused.
A tip to taxpayers
Several other provisions in the reconciliation act also apply to all of 2025—including the deductions for overtime and interest on car loans. Taxpayers will appreciate getting those tax breaks as soon as possible. But without swift action from Treasury and the IRS, taxpayers may face confusion, delays, and missed opportunities on their 2025 returns.
