Many restaurants may need to rethink their mandatory gratuity policies if they want this income to count as qualified tips for their workers under the new tax laws.
The “no tax on tips” provision in President Trump’s One Big Beautiful Bill Act allows certain workers to deduct up to $25,000 in “qualified tips” per year from 2025 through 2028. The rub is that mandatory gratuities, the 15% to 20% that restaurants often impose on parties of six people or more, aren’t eligible for the deduction, a disappointment to the restaurant and foodservice industry, which held out hope for a different outcome.
The industry is the country’s second-largest private-sector employer, providing 15.7 million jobs, or 10% of the total U.S. workforce, according to a data brief from the National Restaurant Association based on the U.S. Census Bureau’s American Community Survey.
The service fee issue is sure to resonate with many restaurateurs. Research from the National Restaurant Association shows that 54% of full-service operators — including 67% of fine-dining operators — say their restaurants sometimes add a service charge or automatic gratuity to customer checks. Among this group, 12% add the service charge or automatic gratuity to all checks, while 88% only add it to parties that exceed a specific number of people (typically six or more) or to banquets, private events or catering events.
Notably, the Internal Revenue Service has never considered these service fees as tips. However, the restaurant industry hasn’t necessarily followed the letter of the law, according to Jean Hagan, a partner at Eisner Advisory Group who focuses on the restaurant industry.
Hagan said during a recent webinar for a large state restaurant association, many proprietors were surprised to learn they weren’t supposed to be counting service fees as tips. “They’ve just always been doing it a certain way — passing on the service fees to employees as a tip,” Hagan said.
Now, however, restaurants will have to put all tips through payroll, even if they weren’t doing it before, or were incorrectly including service fees, so that the employee can benefit from the deduction. There will be more pressure on restaurants to do it properly. “They’ve got to clean their systems up and follow the law as it’s always been,” Hagan said. “If they don’t, the employee won’t get the full benefit of the new tax law.”
Industry lobbying unsuccessful to date
Some advocates for the restaurant industry have been lobbying to change the way service fees are treated. They’d like to see automatic gratuities included as tips. The Culinary Union in Nevada, for example, submitted formal recommendations to the U.S. Department of the Treasury and the IRS that automatic gratuities and suggested tips both be treated as eligible tip income. Separately, several members of Congress from Nevada had asked Treasury Secretary Scott Bessent to ensure that automatic gratuities are deemed eligible for the tips deduction.
“Functionally, for employees, there is no distinction between auto-gratuity and a tip, and inclusion of this income as eligible will prevent arbitrary distinctions between tip practices that would disadvantage workers based solely on the business model of their employer,” lawmakers wrote in an Aug. 12 letter.
However, upending the long-standing distinction between service fees and tips doesn’t appear likely. In September, the IRS issued proposed rules on the new “no tax on tips” deduction. The rules aren’t final yet, but there doesn’t seem to be a lot of wiggle room, since the language within the OBBBA is unambiguous — the tip has to be voluntary. “Congressional intent is pretty clear,” said Andrew Lautz, director of tax policy for the Bipartisan Policy Center. “What’s unclear is how restaurants respond to that,” he added.
Business owners weigh next steps, competitive advantage
Some restaurants are taking a wait-and-see approach.
“Restaurant operators are watching closely for the final ‘No Tax on Tips’ rules from the IRS and will evaluate any shift in their restaurant’s current policies on tipping so that it best suits their tipped employees’ desires,” Sean Kennedy, executive vice president of public affairs for the National Restaurant Association, wrote in an email.
“These employees have chosen a restaurant job because of the income potential they get from tipping, so operators want to make sure that they can take full advantage of the tax credit while it is available to them,” he wrote.
Some restaurants are “consulting with their accountants, point-of-sale providers, and teams to determine what approach works best for their business and employees,” said a spokesperson for the Texas Restaurant Association.
Some business owners may decide to make changes for competitive reasons. “For restaurants who use the commission-based model or utilize service charges, those servers would likely consider it a disadvantage to forego $25,000 of tax-free income when they could potentially move to a restaurant that does not utilize service charges and are therefore eligible for tax-free tips up to $25,000,” said a spokesperson for The Florida Restaurant and Lodging Association.
IRS guidance on making the most of tips tax deduction
Even though the regulations regarding these rules are not yet final, industry participants aren’t expecting much to change with respect to service fees and tip eligibility. At a hearing in October, the IRS reiterated that it is maintaining the stance that service fees aren’t eligible for the deduction, said Scott Klein, senior manager of tax policy and advocacy for the American Institute of CPAs, who attended the hearing. That’s not likely to change in the final regulations, he said.
In its September guidance, the IRS offered several examples of how restaurants can respond so their employees can eke out the most benefit from the deduction under the rules. “If a customer is expressly provided an option to disregard or modify amounts added to a bill, such amounts are not mandatory amounts,” the guidance states.
Say, for example, that a restaurant’s menu states that an automatic 18% charge will be added to all bills for parties of six or more customers. Even if the restaurant distributes this amount to waitstaff, it is not a qualified tip for purposes of the deduction, the IRS said. However, if the restaurant adds a line labeled “additional tip amount” and the customer adds in an amount equal to 2% of the price for food and beverages, the 2% can be considered a qualified tip.
Another option would be for the restaurant to include a “recommended tip” equal to 18% of the price for food and beverages, and include a line for the customer to subtract (including to zero) or add to the recommended tip amount before paying the bill. Say the customer subtracts 3% from the recommended tip amount, resulting in a tip of 15%. The 15% amount that the customer voluntarily paid is a qualified tip in this scenario, according to the IRS.
In another example provided by the IRS, a server presents a customer’s bill on an electronic handheld point-of-sale device, which offers the option to pay 15%, 18%, 20%, other, or no tip. Because the customer has a right to determine the additional amount and was expressly provided the option to leave no tip, the amount chosen is a qualified tip. If, however, the customer was not given an option to modify the amount or leave zero tip, the amount selected would not be a qualified tip for purposes of the deduction.
As restaurant owners and employees weigh their options, the clock is ticking. Because President Trump’s OBBBA is so new, and the IRS is still crafting the applicable regulations, the situation is complicated for restaurants and other businesses whose employees want to claim a deduction for 2025. The AICPA had asked the Treasury Department and the IRS to include a safe harbor for businesses for this tax year, which the IRS issued in early November. This means employers will not face penalties for “failing to provide a separate accounting of any amounts reasonably designated as cash tips or the occupation of the person receiving such tips.”
This safe harbor only applies to tax year 2025.
