Treasury Department Issues Proposed Regulation on “No Tax on Tips”

As we have previously reported, the “One Big Beautiful Bill Act” (OBBBA) provides an above-the-line tax deduction for certain “qualified tips.” To qualify for the deduction, the tips must (among other conditions) be “cash tips” received by an individual engaged in an occupation that “customarily and regularly received tips” on or before December 31, 2024. The Treasury Department has now issued a proposed regulation on the meaning of “cash tips” and defined the occupations that may be entitled to claim the “no tax on tips” deduction. 

A “qualified tip” must be a “cash tip.” The proposed regulation explains that “cash tip” means a “cash medium of exchange,” and includes cash, check, credit card, debit card, gift card, tangible or intangible tokens that are readily exchangeable for a fixed amount in cash (such as casino chips), and any other form of electronic settlement or mobile payment application that is denominated in cash. “Cash tip” does not include items such as event tickets, meals, services, or other assets that are not exchangeable for a fixed amount in cash (such as most digital assets). 

A “qualified tip” must also be voluntary rather than mandatory. The proposed regulation states that service charges, automatic gratuities, and other mandatory amounts added to a customer’s bill are not “qualified tips.” But if customers are expressly provided an option to disregard or modify amounts added to the bill, those amounts are not mandatory. The proposed regulation provides several examples of common tipping/service charge scenarios. 

If a restaurant bill includes a “recommended tip” of 18% but provides a line for the customer to subtract or add to the 18%, any amount left is a “qualified tip.”  

Similarly, if a Point-of-Sale (POS) device prompts a customer to leave a tip of 15%, 18%, 20%, other, or no tip, any amount left is a “qualified tip.” In contrast, if the POS only provides options for 15%, 18%, or 20% (with no ability to modify or decline), then the first 15% is a service charge, not a “qualified tip.” Any amount in excess of 15% is a “qualified tip.”

With respect to occupations that qualify for the tax deduction, the Treasury Department previously released a “preliminary list” of occupations that “customarily and regularly received tips.” The preliminary list consisted of 68 occupations spread across eight industries. The proposed regulation retains that list. 

In the preamble to the proposed regulation, the Treasury Department acknowledged that the list includes occupations (such as dishwashers and cooks) that the U.S. Department of Labor (DOL) and courts have interpreted as *not* customarily and regularly receiving tips for purposes of the tip provisions of the Fair Labor Standards Act (FLSA). The Treasury Department noted that, under the FLSA, employees are generally required to have some level of customer interaction to “customarily and regularly receive tips.” The Treasury Department justified a different interpretation of “customarily and regularly receive tips” for “no tax on tips” based on “differences in the specific language, purpose, and history of the FLSA tip credit and mandatory tip-sharing provisions.” 

The proposed regulation also contains special rules for certain specified service trade or business, and on employees participating in TRDA and GITCA tip-reporting programs.

The list of occupations in the proposed Treasury regulation on “no tax on tips” marks a clear departure from the similar concept under the FLSA. Even though the proposed Treasury regulation suggests liberal sharing of tips would qualify for “no tax on tips,” employers must keep in mind that federal (and often state and local) wage-related rules regarding who may participate in a tip pool are strict, and failing to comply with them can prove costly. Different meanings for the same key terms can lead to confusion, and employers must continue to be careful to comply with all applicable laws.