How the One Big Beautiful Bill Delivers a Tax Trim on Tips for Employers and Employees

Businesses in tip based industries achieved a real victory with the passage of the No Tax on Tips Act as part of the One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025. For the first time in decades, tip based businesses outside the restaurant industry now enjoy the same tax benefits that restaurant owners have received since 1993.

This legislation brings two significant changes. Employees in tipped professions can exclude up to $25,000 of tip income from federal income taxes, and employers can finally claim the FICA Tip Credit that has long been available to restaurant employers.

This represents the correction of a decades old inequity in the tax code. While restaurant owners have been able to claim a dollar for dollar tax credit against the employer portion of FICA taxes paid on employee tips for many years, businesses in other tip based industries have been excluded from this benefit despite operating under similar tipping models. The OBBBA changes provide two separate tip related tax benefits that work differently and benefit different parties.

The No Tax on Tips provision creates an income tax deduction for employees, while the FICA Tip Credit provides a payroll tax credit for employers. These benefits complement each other but operate independently, as explained below.

The No Tax on Tips Provision (Employee Benefit)

Employees who regularly receive tips from customers or clients can now deduct up to $25,000 of their annual tip income when filing their federal income tax returns. This is an above the line deduction, meaning employees can claim it regardless of whether they take the standard deduction or itemize their deductions.

This deduction applies only to employees working in certain occupations where tipping is customary, with eligibility limited to individuals with compensation not exceeding $160,000 in 2025, adjusted annually for inflation. To qualify for this deduction, employees must meet specific requirements. Tips must be voluntary cash tips received during employment in an occupation that customarily receives tips, and must be reported by the employee to the employer for payroll tax withholding purposes. The Treasury Department released a preliminary list of qualifying occupations in September 2025.

While the Treasury Department released a preliminary list of qualifying occupations, it is important to note that the new tax benefits may not apply to every tipped worker, due to what are known as SSTB rules. These rules, which stand for specified service trade or business, could exclude certain workers from claiming the No Tax on Tips provision depending on the specific setting they work in. This benefit is available through December 31, 2028, although the provision may be extended or made permanent in the future.

Even though employees can now deduct tip income from their federal income taxes, they must still pay their share of FICA taxes, Social Security and Medicare, on all reported tips. The No Tax on Tips provision only affects federal income tax liability. It does not eliminate or reduce the employee's FICA tax obligation on tips. This means employees will continue to see FICA withholdings on their pay stubs for all reported tip income.

Importantly, regardless of whether an employee claims the deduction, they are still required to report all tip income to their employers and the IRS. This reporting requirement is separate from and unrelated to the new tax benefits. It is an existing federal obligation that remains unchanged.

The FICA Tip Credit (Employer Benefit)

The FICA Tip Credit now also allows business owners in tip based industries to claim a dollar for dollar tax credit against the employer portion of FICA taxes on employee tips. This credit reimburses employers for the 7.65 percent in Social Security and Medicare taxes they pay on tips their employees receive, money that flows directly to workers rather than staying with the business.

While employers can now claim the FICA Tip Credit to recover the employer portion of FICA taxes paid on employee tips, they must first pay these taxes through the normal payroll process. The credit is claimed later when filing annual tax returns. It is not an upfront exemption from paying FICA taxes.

Employers remain fully responsible for withholding and remitting both the employee and employer portions of FICA taxes on all reported tips through regular payroll cycles. The employer must also continue to match the employee's FICA contributions as required by law. The FICA Tip Credit then reimburses the employer for their portion after taxes are paid and properly reported. This means cash flow timing matters, since employers pay FICA taxes throughout the year via payroll but receive the credit benefit when filing their annual return or through quarterly estimated tax adjustments.

Employers should be aware that failure to make timely FICA deposits can result in significant penalties ranging from 2 percent to 15 percent of the unpaid tax, depending on how late the deposit is and whether or not a notice has been issued, so maintaining proper payroll tax compliance remains critical even while planning to claim the credit.

Claiming the FICA Tip Credit requires active steps by employers. Employers must claim this credit on their annual tax returns using Form 8846, Credit for Employer Social Security and Medicare Taxes Paid on Certain Employee Tips. Employers must maintain documentation showing the amount of tips reported by each employee, the corresponding FICA taxes paid, and verification that the tips qualify under the credit requirements.

Unlike the temporary employee deduction, the FICA Tip Credit for tip based businesses is not set to expire, providing long term planning certainty. There are no income limitations for employers claiming this credit, and it applies to all qualifying reported tips from eligible employees in covered occupations. Business owners should note that this credit reduces dollar for dollar the federal taxes owed. It is not a deduction that reduces taxable income, but rather a direct reduction of tax liability.

The combination of employee No Tax on Tips deductions and employer tax credits creates a robust incentive structure that benefits all parties. Workers keep more of their earnings, employers reduce their tax burden, and tip based industries gain recognition for their economic contributions. This legislation not only corrects a long standing inequity but also paves the way for a more prosperous future for these industries.

For businesses built on personal service and client relationships, this legislation ensures that both employees and business owners are rewarded fairly for their dedication to their work. Have questions about implementing these changes or need assistance with tax planning strategies? You can book a complimentary 30 minute consultation online at AzarvandTaxLaw.com or by sending us an email at [email protected].