Like the overtime deduction, the tips deduction lives on the employee's tax return, not in payroll. An employer with tipped staff has the same tip-reporting duties as before, plus new boxes on the 2026 Form W-2. This post covers who qualifies, which payments count as tips, what a pay stub should show and what changes at year end.
The tips deduction in brief
| Rule | What the IRS says |
|---|---|
| Years | 2025 through 2028 |
| Maximum deduction | $25,000 a year |
| Income limit | Phases out when modified adjusted gross income is over $150,000 ($300,000 joint) |
| Occupations | Only occupations on the IRS list of those that customarily and regularly received tips on or before 31 December 2024 |
| Who can claim it | Employees and self-employed people with a valid Social Security number; married couples must file jointly |
| Not eligible | Self-employed people in a specified service trade or business, and employees of such a business |
| Self-employed limit | The deduction can't exceed net income from the business the tips came from |
| Where it is claimed | On the federal return (Schedule 1-A), itemizing or not |
The IRS's examples of tipped occupations include wait staff, bartenders, salon workers and personal trainers. Each listed occupation has a three-digit Treasury Tipped Occupation Code, and that code now appears on the employee's W-2.
What counts as a qualified tip
Qualified tips are voluntary cash or charged tips received from customers or, for employees, through a tip-sharing arrangement. "Cash" here includes tips paid by card; it means money rather than goods. The IRS test for any tip is that the customer decides voluntarily whether to pay it and how much.
| Payment | Qualified tip? |
|---|---|
| Cash left on the table by a customer | Yes, if the occupation is on the list |
| Tip added on a card payment by the customer | Yes |
| Share of a tip pool paid out to an employee | Yes, through a tip-sharing arrangement |
| Automatic service charge on large parties | No. A mandatory charge is the business's income and becomes ordinary wages when paid to staff |
| Event tickets or other non-cash gifts | No. Only cash and charged tips count |
Tips on the pay stub
Nothing about withholding changes. Employees must still give their employer a written report of cash tips by the 10th of the following month whenever they receive $20 or more in a calendar month. The IRS's W-2 instructions say tips are generally subject to federal income tax withholding and to both the employee and employer shares of Social Security and Medicare once they reach $20 a month. An employee who expects the deduction can lower withholding by giving the employer a new 2026 Form W-4 that includes it in Step 4(b).
A clear pay stub shows reported tips on their own line, separate from hourly wages and from any service-charge payouts, which are wages. Tips the customer paid in cash were already in the employee's pocket, so they appear in gross pay for tax purposes but are not paid again in the paycheck. Card tips paid out through payroll appear as earnings and are paid in the check.
| Line | Amount | Paid in this check? |
|---|---|---|
| Hourly wages: 30 hours × $12.00 | $360.00 | Yes |
| Card tips paid through payroll | $240.00 | Yes |
| Cash tips reported by the employee | $180.00 | No, already received |
| Gross pay for tax purposes | $780.00 |
Withholding, Social Security and Medicare are figured on all $780. The illustration ignores tip credits and state rules on tipped minimum wage, which differ by state.
What changes on the 2026 W-2
- Box 12, code TP: the total cash tips the employee reported to the employer for the year.
- Box 14b: up to two Treasury Tipped Occupation Codes for the occupations the tips were received in. Box 14 is split into 14a (other) and 14b.
- Boxes 7 and 8 keep their old jobs: Social Security tips and allocated tips.
- For 2026 Forms W-2, the IRS lists 1 February 2027 as the date to furnish them to employees and file them with the Social Security Administration.
For 2025, employers did not have to report qualified tips separately, and the IRS gave them penalty relief for that year. Employees work out their 2025 amount from their own records and the Schedule 1-A instructions. On Forms 1099-NEC and 1099-MISC for 2026, cash tips and the occupation code have their own boxes too (1b and 1c on the NEC, 13a and 13b on the MISC).
A checklist for employers with tipped staff
- Find the Treasury Tipped Occupation Code for each tipped role and keep it in the employee's file.
- Keep collecting monthly tip reports from employees, and withhold on reported tips.
- Keep mandatory service charges out of tips in your records; pay them as wages.
- Show tips on separate pay stub lines, with cash tips marked as already received.
- Accept new 2026 Forms W-4 from employees who want less withheld.
- At year end, total each employee's reported cash tips for W-2 box 12 code TP and enter the occupation code in box 14b.
Large food and beverage establishments still file Form 8027 each year and allocate tips when reported tips fall below 8% of gross receipts. None of that changes with the new deduction.
Where PayDocs fits
In the PayDocs pay stub generator you can add each earning on its own line, so card tips, reported cash tips and service-charge payouts stay separate from hourly wages. The W-2 generator makes employee copies of the 2026 Form W-2 with box 12 code TP and box 14b, and it asks for the occupation code when you enter code TP. The paycheck calculator estimates withholding on a gross figure you enter, tips included.
PayDocs doesn't track tips over the month, decide which occupation code applies, file Form 8027 or any other return, or tell an employee how much they can deduct. It turns your figures into clear documents.
Questions
Are tips still taxed on the paycheck?
Yes. Reported tips are still subject to federal income tax withholding, Social Security and Medicare. The deduction reduces federal taxable income on the employee's return, up to $25,000 a year.
Does an automatic gratuity count as a tip?
No. The IRS says a payment is a tip only if the customer decides voluntarily to pay it and decides the amount. Mandatory service charges are the business's income and ordinary wages when paid to staff.
Which jobs qualify for no tax on tips?
Only occupations on the IRS list of those that customarily and regularly received tips on or before 31 December 2024, such as wait staff, bartenders and salon workers. Each has a Treasury Tipped Occupation Code, which goes in W-2 box 14b from 2026.
Do employees still have to report tips to the employer?
Yes. Employees give a written report of cash tips by the 10th of the next month when they receive $20 or more in a month. Unreported tips go on Form 4137 with the employee's return.
Sources
- IRS: Working Families Tax Cuts, tax deductions for working Americans and seniors
- IRS: One, Big, Beautiful Bill, how to take advantage of no tax on tips and overtime (Tax Tip 2026-06)
- IRS: Tip recordkeeping and reporting
- IRS: General Instructions for Forms W-2 and W-3 (2026)
- IRS: Instructions for Forms 1099-MISC and 1099-NEC (Rev. December 2026)
Sources checked October 4, 2026. This article explains how pay documents work; it is not tax or legal advice.
