OBBBA –Tips Tax Exemption: What Employers and Payroll Teams Need to Know for 2026-2028
On April 10, 2026 the Internal Revenue Service released the final regulations on the new tax exemption on qualified tips established by the One Big Beautiful Bill Act (OBBBA) in July 2025. The final regulations define qualified tips and provide a detailed list of qualified tipped occupations.
For employees, this is good news: some of their qualified tip income can now reduce their federal and in most cases state tax bill. For employers and payroll teams, it creates new reporting responsibilities, which require prompt action to ensure proper payroll setup and correct year end reporting.
The IRS reported that there is heightened interest in the new tip and overtime exemptions utilized by more taxpayers that initially anticipated, so the IRS will be applying more scrutiny to the reporting and the personal tax filings to ensure compliance.
Strongpay is working diligently to update the payroll system according to the final IRS regulations and we will notify you when ready and the actions you need to take to update the employees records with the proper occupational codes.
This is a federal income tax deduction on the employee's personal tax return—not an exemption from payroll taxes. Tips are still taxed in payroll as usual and subject to Federal and State income taxes as well as Social Security and Medicare (FICA) taxes. The only change in payroll is additional reporting for cash tips on Form W-2 starting with the 2026 Forms W-2 issued in January 2027.
What is the no tax on tips exemption?
The tax exemption is in effect for tax years 2025 through 2028.
Employees and self-employed workers in qualified tipped occupations that traditionally receive tips may deduct on their personal tax return up to $25,000 of qualified tip income from their federal taxable income per year.
There is a phase out of the deduction for individuals with modified adjusted gross income over $150,000 ($300,000 for joint filers).
What is a qualified tip?
Qualified tips are only voluntarily provided by the customer cash or cash-equivalent tips (including charged tips and tip-pool distributions). The tips are not subject to negotiation, and the tip amount is determined by the customer.
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To be qualified the tips have to be reported on Form W-2, Form 1099-NEC, Form 1099-MISC, Form 1099-K, or another statement furnished to the individual, or on Form 4137 if the individual reports the tips directly to the IRS.
What is NOT a qualified tip?
Mandatory service charges—an automatic gratuity added to a check (e.g., 18% for large parties) that the customer cannot opt out of or modify is not a qualified tip, even if it is distributed to employees.
Tips from non-qualifying occupations—if the employee’s job is not on the qualifying occupation list, their tips do not qualify for the deduction.
Employees of an employer in a Specified Service Trade or Business (SSTB) under Section 199A(d)(2).
Tips paid by the company to individuals with ownership interest (5% or more) in the company or employed by the payer of the tip.
Tips from illegal activity.
What is NOT allowed?
Employers cannot shift compensation structures to take advantage of the deduction. The following practices are not allowed:
Lowering hourly wages and replacing them with expected tips.
Re-labeling commissions, bonuses, or incentive pay as tips.
Paying guaranteed tips not voluntarily provided by the customer.
Who qualifies?
Eligibility for the tips tax deduction depends on the employee’s occupation and requires a valid SSN. The IRS published the final list of qualified tip occupations with assigned three digit occupation codes (TTOC). They are grouped in eight main categories. Some examples are included below but please review the complete list here.
Food and beverage service: wait staff, bartenders, bussers, baristas, food delivery workers
Beauty and personal care: hairstylists, nail technicians, estheticians, massage therapists
Transportation: taxi drivers, rideshare drivers, valets, bellhops
Hospitality: hotel housekeeping staff, casino dealers
Fitness and wellness: personal trainers, yoga instructors
Other: car wash attendants, pet groomers, tour guides
Kitchen staff who participate in a tip-sharing pool are also included in the proposed list
What is the new W-2 reporting requirement for tips?
Based on the available preliminary IRS instructions, beginning with the 2026 Forms W2, employers must report:
Box 12, Code TP—the total amount of cash tips (not just qualified tips) reported to the employer. The IRS advises employees to keep track of cash tips received from qualified and nonqualified occupations, so they can report the proper tip exemption on their personal tax return.
Box 14b—the Treasury Tipped Occupation Code(s) (TTOC) for the employee’s qualifying occupation(s). Use “000” for nonqualified occupation
IRS allows up to 2 codes to be entered.
If the employee works in more than 2 qualified tipped occupations – enter any two of the codes.
If the employee works in more than 2 tipped occupations and one of them is a nonqualified occupation, use “000” for one of the codes.
What Strongpay Is Handling
Report total cash tips and TTOC occupation codes on 2026 Forms W-2 using Box 12 Code TP and Box 14b.
Continue normal federal and state income tax withholding on all tips—no change there.
Notify you when the payroll system is updated with the final list of tip occupation codes published by the IRS.
Provide employee-facing FAQ you can share with your team.
What Employers Must Do
The most important action items are simple but critical:
| # | Action | What it means for you |
|---|---|---|
| 1 | Track cash and charge tips accurately | Review the tips earnings code setup and ensure that cash and charge tips are properly classified in payroll. *Service charges are not qualified tips. *Ensure wages are not reclassified as tips. |
| 2 | Assign tipped employee occupation codes | Strongpay will notify you when the final tipped occupation codes are available in the payroll system, so you can assign the correct TTOC code for 2026 W-2 reporting. |
| 3 | Prepare for employee questions | Employees may ask why their tips were—or weren't—reported or what the amount in W-2 box 12 with code TP represents. If employees have questions about how to report the tip exemption on their personal tax return, direct them to their tax advisor for guidance. |
Common Employee Questions—and How to Answer Them
Here are some sample employer responses for common employee questions:
Will I pay less taxes on my tips this year?
Possibly. If your job is on the IRS list of qualifying occupations, you may be able to deduct qualified voluntary cash/charge tips up to the allowed limit on your personal tax return. Consult with your personal tax advisor if you qualify for the tip exemption and how to claim it. Please note: there is no change how tips are taxed in payroll, so there is no change to your paycheck withholding.
Why are taxes still being withheld from my tips?
The deduction for qualified tips is claimed on your personal tax return, not through payroll. Employers are required to treat tips as taxable wages during the year, and they are subject to federal and state income tax withholding as well as Social Security and Medicare taxes.
Can I complete a new W-4 to reduce my taxes in payroll in anticipation of claiming the tip deduction on my personal tax return?
Yes, you may update your 2026 Form W-4 to reflect anticipated deductions, including estimated qualified tip deductions.
Important: the deductions are based on your estimate, so it is advisable to take a conservative approach to avoid under withholding and taxes due on your personal tax return at the end of the year. Consult with your tax return preparer to review your financial situation and advise how to complete Form W-4 to ensure proper federal income tax withholding. If in doubt, it is advisable not to change your W-4 but claim these deductions on your personal tax return at the end of the year instead.
Can I claim the deduction for tips I did not report to my employer or to the IRS on Form 4137?
No, only properly reported tips are eligible for payroll reporting and may be required for deduction eligibility.
How will I know the amount to deduct?
For 2026 and beyond, your W-2 will include the total cash tips amounts in Box 12 Code TP as well as the occupation code in box 14b. The W-2 will report the total cash tips, so the IRS advises employees to keep track of cash tips received from qualified and nonqualified occupations in order to report the correct amount of qualified tips on your personal tax return.
For 2025, those amounts may not appear separately on the W-2. The IRS has provided instructions for how to calculate the amounts using your pay stubs.
Will my employer calculate the deduction for me?
Employers cannot calculate the tip deduction to be claimed on your personal tax return. Consult with your tax return preparer for further guidance.
Sources & Official Guidance
The information in this article is based on official IRS and Treasury guidance current as of April 2026. Some regulations referenced below remain in proposed form. Strongpay will update this content as final guidance is released.
Questions about your payroll setup?
Contact your Strongpay account team or reach out at payroll@strongpay.com. We will guide you through confirming your tipped employee setup before the 2026 reporting year.