Restaurants Reassess Tip Policies Due to New Tax Law
Restaurants might need to rethink their mandatory tipping practices to ensure that their employees can benefit from a new tax law. This law, part of President Trump’s One Big Beautiful Bill Act, introduces a “tip tax exemption” that allows certain workers to deduct up to $25,000 in “qualified tips” each year from 2025 to 2028. However, the automatic tips typically added for larger groups—usually 15% to 20%—are not included in this deduction, which is quite disappointing for those in the restaurant and food service sector.
The restaurant industry is significant, employing around 15.7 million people in the U.S.—that’s about 10% of the entire workforce. According to a report from the National Restaurant Association, which draws from the U.S. Census Bureau’s data, this sector stands as the second-largest private employer.
This issue really hits home for many in the business. A survey revealed that 54% of full-service restaurant operators, including a notable 67% of fine-dining establishments, sometimes apply a service charge. While 12% consistently apply this service charge to every check, the remaining 88% only do so for larger groups or specific events.
Interestingly, the IRS has historically not recognized these service charges as tips. Still, Jean Hagan, a partner at the Eisner Advisory Group, mentioned during a recent webinar that many business owners were surprised to learn that service charges shouldn’t be classified as tips. “It’s just the way they’ve always done it—distributing the service charge to employees,” he described.
From now on, restaurants must ensure proper reporting of all tips on payroll. If not, employees may miss out on valuable tax deductions. “They need to clean up their systems and comply with regulations,” Hagan emphasized. “Otherwise, employees won’t fully benefit from this new tax law.”
Industry Lobbying Efforts Encounter Hurdles
Some advocates within the industry are campaigning for changes in how service charges are classified. For instance, the Nevada Culinary Union has made formal requests to the U.S. Treasury and the IRS to include automatic and suggested tips as qualified income. A group of Nevada Congress members has also reached out to Treasury Secretary Scott Bessent to affirm the eligibility of automatic tips for deductions.
In their appeal, lawmakers noted, “For employees, there’s really no difference between gratuities and tips. Including this income would prevent arbitrary distinctions in tipping practices that unfairly affect workers based on the business model.”
Despite these efforts, it looks doubtful that the longstanding distinction between service charges and tips will be changed. The IRS proposed new rules in September about the “Tip Tax Free” deduction, and it seems there’s minimal wiggle room left for adjustments regarding the voluntary nature of tipping. “Congress’s intent is quite clear,” said Andrew Lautz, of the Bipartisan Policy Center, adding some uncertainty about restaurants’ potential responses.
Business Owners Weigh Their Options
Many restaurant owners are in a holding pattern. They’re keenly watching the IRS as it finalizes the new rules. Sean Kennedy, from the National Restaurant Association, noted in an email that restaurateurs will consider how best to adjust their policies to align with the preferences of tipped employees.
Some in the industry are also reaching out to accountants and point-of-sale systems to determine the best way forward. A spokesperson for the Florida Restaurant and Lodging Association indicated that competition might nudge restaurants to adjust their practices. “Servers will likely not want to lose the $25,000 in tax-free income if they switch to establishments that don’t use service charges,” the spokesperson noted.
IRS Guidance on the Tip Tax Deduction
While the rules are not yet finalized, experts don’t anticipate significant revisions to service charge classifications. At an October IRS hearing, it was reiterated that service fees are non-deductible. Scott Klein, a tax policy manager, expressed skepticism about any final changes.
In recent guidance from September, the IRS provided examples for restaurants to help employees maximize deductions. For instance, if customers can choose to ignore or alter a fee on an invoice, it won’t be classified as a required charge. An automatic 18% surcharge on bills for large parties, while distributed to staff, doesn’t count as a qualified tip. Conversely, if a restaurant allows customers to add a tip voluntarily, that amount could qualify.
Time’s running out for owners and employees as they navigate these changes. With the new tax law still unfolding, there’s added pressure, especially for those looking to benefit from the 2025 deduction. The AICPA has urged the Treasury and IRS to implement a safe harbor for this tax year, noting that employers won’t be penalized for failing to track amounts designated as cash tips.
This safe harbor remains applicable only for the 2025 tax year.
