Advocacy Update l Tipped Workers and Voluntary Gratuity Outlined for No Tax on Tips

What’s Happening: 

The Department of Treasury released guidance  that allows certain workers to deduct up to $25,000 in “qualified tips” per year from 2025 through 2028. Restaurant occupations are widely eligible for the tax deduction on tipped income. The Treasury Department also illustrated how service charges are different from a tip, as are service charges being mandatory and a tip (which qualifies for the tax deduction) is given at the voluntary discretion of the customer. This is key for restaurant operators who want to ensure their tipped worker’s income is eligible for the No Tax on Tips deduction when they work a large party – operators may be considering a transition from a traditional large party service fee, which would not be a traditional tip and therefore ineligible for the tax deduction.

What makes a tip different from a service charge (p. 7):

Revenue Ruling 2012-18 provides that the absence of any of the following factors creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge: (1) the payment must be made free from compulsion, (2) the customer must have the unrestricted right to determine the amount, (3) the payment should not be the subject of negotiation or dictated by employer policy, and (4) generally, the customer has the right to determine who receives the payment.

Example (p. 48):

Example 3. Customer E dines at Restaurant X with a party of eight people. E’s bill for food and beverages for the party of eight includes a “recommended tip” equal to 18% of the price for food and beverages. However, there is a line for the customer to subtract (including to zero) or add to the recommended tip amount before paying the bill. Customer E subtracts 3% from the recommended tip amount resulting in a tip of 15% of the price for food and beverages. Customer E had a right to determine the additional amount, and he was expressly provided the option to disregard or modify the “recommended tip” amount. Under these circumstances, the recommended 18% mount is not a service charge. Rather, the 15% amount that the customer voluntarily paid without compulsion is a qualified tip for purposes of the deduction under section 224.