No tax on tips: what the new deduction means for restaurant employers

From 2025 through 2028, workers in tipped occupations can deduct up to $25,000 of qualified tips on their federal returns. The deduction belongs to employees, but it depends on accurate reporting by employers.

How the deduction works for staff

• Up to $25,000 a year of qualified tips per return. Married workers must file jointly, and a couple shares one cap.
• Reduced by $100 per $1,000 of modified AGI above $150,000, or $300,000 for joint filers.
• Available whether or not the employee itemizes.
• It's an income tax deduction only. Social Security and Medicare still apply to tips.

In Connecticut

The deduction doesn't reduce Connecticut income tax. It is taken on Schedule 1-A after adjusted gross income, and Connecticut's return starts from federal AGI with no matching subtraction. Tips remain Connecticut wages for withholding, and reported tips also count toward the employee's 0.5% CT Paid Leave contribution.

Qualified tips

• Paid voluntarily by the customer, with the amount set by the customer.
• Received in an occupation the IRS lists as one that customarily received tips before 2025, a list that includes servers, bartenders, bussers, hosts, baristas, delivery drivers, and many more.
• Cash or charged tips, including tips distributed through a valid tip-sharing or pooling arrangement.

Mandatory service charges, automatic gratuities on large parties, and any other charge added to the bill that the customer can't reduce to zero do not qualify.

Key numbers: $25,000 cap · phase-out above $150,000 / $300,000 · 2025–2028 · service charges excluded.

Employer reporting

Employers must report on the W-2 each employee's total cash tips reported to the employer, along with the employee's tipped occupation. Employees then work out which of those tips qualify. The IRS allowed transitional relief for 2025. On 2026 W-2s, due February 1, 2027, tips go in box 12 with code TP, and Treasury Tipped Occupation Codes go in new box 14b. Practical steps for employers:

1. Map every tipped position to the IRS occupation list.
2. Separate voluntary tips from service charges in the POS and payroll system.
3. Confirm tip pool distributions are documented by employee and pay period.
4. Explain to staff how to read the new W-2 information.

Rethinking service charges

Some restaurants moved to service charges to stabilize pay. Under the new deduction, those amounts are wages for staff, and they also don't count for the FICA tip credit. Converting back to voluntary tips may benefit both employer and employees, though state wage rules and the guest experience should be weighed. In Connecticut, a mandatory service charge is also subject to the 7.35% meals tax unless the restaurant keeps none of it and pays all of it to the staff who served the meal.

A worked example

A bartender earns $28,000 in wages and $34,000 of reported voluntary tips. Her MAGI as a single filer is $62,000. She deducts $25,000, which reduces her federal taxable income and saves about $3,000 at a 12% bracket. The restaurant, meanwhile, claims the FICA tip credit on the same tips.

Common mistakes

1. Paying out credit card tips without matching them to employee records.
2. Labeling an automatic 20% gratuity as a tip.
3. Missing occupation codes on W-2s.

How Summer Associates helps

Summer Associates reviews your POS and payroll setup for the new reporting, classifies service charges and tips correctly, and coordinates both with the FICA tip credit.

This guide is general education based on federal and Connecticut law as of 2026-11-15. State rules differ and facts matter. Before acting, get advice for your situation from Summer Associates or another qualified advisor.