IRS issues final regs on new tip deduction

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The IRS issued final regulations on April 10 addressing the key elements of the new tax benefit for tip income included in the One Big Beautiful Bill Act (OBBBA), which allows individuals an above-the-line deduction on their Forms 1040 for qualified tips received in the 2025-2028 calendar years. The IRS issued proposed regulations in September 2025, and the final regulations include a number of clarifications and new provisions but generally adopt the proposed regulations with relatively minimal changes.

Under the new law, the term “qualified tips” generally means cash tips received by an individual in an occupation that customarily and regularly received tips on or before Dec. 31, 2024.

The final regulations generally adopt the definition of “cash tips” provided in the proposed regulations, defined as tips received from customers or, in the case of an employee, through a mandatory or voluntary tip-sharing arrangement, such as a tip pool, that are paid in a cash medium of exchange. This includes by 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 denominated in cash.

Cash tips generally do not include items paid in any other form, such as event tickets, meals, services or other assets that are not exchangeable for a fixed amount of cash. The final regulations also clarify whether certain specific types of payments constitute cash tips. For example, amounts paid in foreign currency do qualify, but digital assets, including stablecoins, do not.

Qualified tips must be paid voluntarily and without any consequence in the event of nonpayment, must be the subject of negotiation and must be determined by the payor. The final regulations generally adopt, with some clarifications, the guidance in the proposed regulations regarding these rules, generally providing that service charges, automatic gratuities and other mandatory amounts automatically added to a customer’s bill by the vendor or establishment are not qualified tips unless the customer is expressly provided with an option to disregard or modify them without consequence.

As required by the OBBBA, the IRS published in the proposed regulations a list of 68 specific occupations that customarily and regularly received tips on or before Dec. 31, 2024. Each is assigned a three-digit code called a Treasury Tipped Occupation Code (TTOC), grouped together in eight general occupation categories. The final regulations generally adopt the previously published list (PDF - 193.01KB) of occupations that receive tips, modifying it to include three new TTOCs — gas pump attendant, visual artists and floral designers — and including a number of clarifications to certain previously published TTOCs.

Consistent with the statutory language (new Section 224), the proposed regulations provided that qualified tips do not include those received in the course of a specified service trade or business (SSTB) as defined in Section 199A(d)(2).

This generally includes services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners, or that includes the performance of services that consist of investing and investment management, trading or dealing in securities, partnership interests or commodities.

This rule applies even if the employee of an SSTB works in an occupation that customarily and regularly receives tips.

However, in Notice 2025-69, which was issued after the proposed regulations, the IRS acknowledged that additional guidance is needed for employees and employers to apply the SSTB rules, and the notice provided transition relief until Jan. 1 of the first calendar year following issuance of final regulations that include this additional guidance.

Until the end of the transition period, the IRS will treat an employee as having received tips in the course of a trade or business that is not an SSTB if the employee is in an occupation that traditionally receives tips (regardless of whether the employer’s trade or business is a SSTB).

The final regulations do not provide any guidance regarding the SSTB rules, and the preamble confirms that the IRS intends to issue proposed regulations in the future and solicit public comments regarding the SSTB rules before publishing final regulations. Notice 2025-69 also provides guidance and examples of how employee and nonemployee service providers should determine the amount of qualified tips that may be deductible in 2025, including four specific approaches for employees.

The OBBBA also requires service recipients (i.e., employers) to separately report the amount of qualified tips, along with specified occupation details, to workers on Form W-2 or Form 1099-NEC, as applicable. This is a significant shift from prior reporting practices, under which tips and overtime were generally aggregated with regular wages on Forms W-2 or 1099 without occupation details.

Earlier guidance (Notice 2025-62) granted employers temporary penalty relief for 2025 from the new reporting requirements. As a result, employers and other payors were not required to separately account for cash tips on Forms W-2 or 1099 for 2025. However, Notice 2025-62 encouraged employers to provide employees with separate accountings of cash tips, including occupation codes, to assist them in determining eligibility for the 2025 deductions.

To prevent abuse of the new tip deduction by taxpayers attempting to recharacterize income as qualified tips, the final regulations include new anti-abuse provisions. Under the final regulations, an amount is not eligible for deduction if, based on all relevant facts and circumstances, the amount represents a recharacterization of wages or payments for goods or services for purposes of claiming the deduction.

In this regard, the final regulations provide that the following facts and circumstances may indicate a recharacterization of income as tips:

• A charge for services provided on an invoice is less than the payment from the payor shown on a related receipt or information return, and the cash tip reported on the receipt or information return approximates the difference between the charge amount on the invoice and payment amount on the receipt or information return.
• A significant shift occurs from historical tipping or payment practices between the payor and the tip recipient.