“No tax on tips” sounds like tips became tax-free. They did not. The benefit is real, but it is narrower than the name, and in New Jersey it comes with a catch.
Here is the plain version for NJ restaurants and tipped staff. “No tax on tips” is a federal income-tax deduction — up to $25,000, for 2025 through 2028. It does not remove Social Security and Medicare tax. And New Jersey does not honor it, so NJ tax on tips continues. Every figure below is sourced to the IRS or the NJ Division of Taxation, current as of June 29, 2026.
Key takeaways:
- It is a deduction, not an exemption — up to $25,000 per return.
- It is federal income tax only. FICA (Social Security + Medicare) still applies.
- New Jersey does not conform — NJ still taxes the tips.
- It runs for tax years 2025–2028 and phases out at higher incomes.
- For restaurant owners, payroll and reporting barely change — the deduction is the employee’s.
It is a deduction, not an exemption
The One Big Beautiful Bill Act created a new deduction for “qualified tips” under IRC Section 224 (IRS). A tipped worker can deduct up to $25,000 of qualified tips per return.
Two helpful details:
- You can claim it whether or not you itemize.
- It applies for tax years 2025 through 2028 (it is retroactive to January 1, 2025).
It phases out for higher earners — by $100 for every $1,000 of modified adjusted gross income over $150,000 (single) or $300,000 (joint).
FICA still applies — the misleading part
This is the point that surprises people. The deduction reduces federal income tax only. Social Security and Medicare tax still come out of tips (IRS).
So a server still pays the 7.65% employee FICA share on their tips. The restaurant still withholds and pays its FICA share too. “No tax on tips” never touched payroll tax — only the income-tax line.
Who qualifies — and what counts as a tip
The deduction is for workers in occupations that customarily and regularly received tips on or before December 31, 2024. The IRS final regulations list more than 70 qualifying occupations — servers, bartenders, and similar roles (IRS final regulations).
What counts as a qualified tip:
- Voluntary tips the customer chooses to leave — cash, card, or check.
- Tips received directly or through a valid tip-sharing arrangement.
What does not count:
- Mandatory service charges or automatic gratuities (the 18% added to large parties).
- Amounts paid in digital assets.
New Jersey does not conform
Here is the NJ catch. New Jersey did not adopt the federal deduction. The NJ Division of Taxation has confirmed the OBBB deductions for tips and overtime do not affect a New Jersey return. We cover the full list of NJ non-conforming items in our OBBB tax provisions guide for NJ businesses.
In practice: a Bergen County server gets a lower federal tax bill, but still owes NJ Gross Income Tax on the same tips. The benefit is real, just federal-only.
Service charges are not tips
This distinction decides whether the deduction applies, and it trips up a lot of restaurants. A tip is voluntary — the customer chooses the amount. A service charge is mandatory — the restaurant adds it automatically.
The classic example is the automatic 18% gratuity added to a party of six or more. Because the customer cannot choose to skip it, the IRS treats it as a service charge, not a tip. It does not qualify for the deduction. It is also treated as regular wages for the worker, not tip income.
So a server’s voluntary tips can qualify, while the auto-gratuity on a large table does not. How your point-of-sale system labels each line matters. If “tips” and “service charges” are mixed together in payroll, the qualifying amount gets muddy. Clean separation at the POS level is what keeps the deduction defensible.
What tipped workers should do this year
A few practical steps help servers and bartenders actually capture the benefit:
- Report all your tips. The deduction only applies to tips that are reported — on your W-2 or on Form 4137. Unreported cash tips cannot be deducted.
- Keep a simple tip log. A daily record supports the number you claim.
- Remember the NJ side. Your federal tax drops, but your NJ tax on tips does not. Do not assume your NJ refund changes.
- Watch the phase-out. If your total income is high, part of the deduction may be reduced.
What restaurant owners should do
For owners, the day-to-day barely changes — but a few things matter:
- Keep reporting tips accurately. Tips still go on the employee’s W-2, and tip recordkeeping rules are unchanged.
- Keep withholding and paying FICA on tips as before. The deduction does not change payroll tax.
- The deduction is the employee’s, claimed on their own return — not something the restaurant files.
- The employer FICA tip credit (Form 8846) still applies — owners can still claim it on the employer FICA paid on tips.
Clean payroll and tip reporting are what make this work for your staff. Our restaurant CPA services and payroll setup keep tip reporting, withholding, and the FICA tip credit straight, so your team gets the federal benefit without a compliance mess. Schedule a free consultation to review your payroll setup before year-end.
No tax on tips FAQ
Is ‘no tax on tips’ really no tax?
No. It is a federal income-tax deduction of up to $25,000 per return for qualified tips, in effect for tax years 2025 through 2028. It only reduces federal income tax. Social Security and Medicare (FICA) taxes still apply to tips, and the name oversells it.
How much can a tipped worker deduct?
Up to $25,000 of qualified tips per tax return. The deduction is available whether or not you itemize. It phases out for higher earners — by $100 for every $1,000 of modified adjusted gross income over $150,000 for single filers, or $300,000 for joint filers.
Do New Jersey servers still pay NJ tax on their tips?
Yes. New Jersey does not conform to the federal deduction. The NJ Division of Taxation has confirmed the OBBB deductions for tips and overtime do not affect a New Jersey return. So a NJ server still pays NJ Gross Income Tax on tips even though the federal deduction lowers their federal tax.
Which workers qualify for the tips deduction?
Workers in occupations that customarily and regularly received tips on or before December 31, 2024. The IRS final regulations list more than 70 qualifying occupations, including servers, bartenders, and similar roles. Only voluntary tips count — cash, card, or check tips the customer chooses to leave. Mandatory service charges and automatic gratuities do not qualify.
What do restaurant owners need to change in payroll?
Keep reporting and withholding on tips as you do today. Employers still report tips on the employee’s W-2 and still withhold and pay FICA on them. The new deduction is claimed by the employee on their own federal return, not by the restaurant. The employer FICA tip credit (Form 8846) still applies to the employer FICA paid on tips.
How does a server actually claim the deduction?
On the federal individual return. The qualified tips, reported on the worker’s Form W-2 or on Form 4137, are deducted on Schedule 1-A of Form 1040. Keeping accurate tip records during the year makes this straightforward at filing time.
This article is general information for New Jersey restaurants and tipped workers. It is not tax or accounting advice and does not create a CPA-client relationship. Figures are current as of June 29, 2026 and are sourced to the IRS (IRC Section 224 and final regulations) and the NJ Division of Taxation. Confirm your situation with a licensed CPA before you act.