Recent changes to tip deductions and reporting requirements have added new considerations for organizations. Employers must understand and apply these updates to maintain compliance.
A key provision of the One Big Beautiful Bill Act (OBBBA) establishes that up to $25,000 in qualified tipped income may be exempt from federal income tax for employees and certain self-employed individuals, such as wait staff, bartenders, and gig economy workers. This change increases the administrative demands of tip management and makes manual tracking methods less reliable. Organizations should confirm that their payroll processes can accurately support these updated requirements and reduce the risk of errors.
Tips or Service Charges? How to Classify Correctly
OBBBA requires a clear distinction between mandatory service charges and tips. Proper classification and reporting help ensure employees can take advantage of the tax deduction.
- Mandatory service charges are not considered tips under IRS guidelines. These are required amounts added to customer bills, often for large parties or special events.
- Tips are voluntary payments that customers provide for service.
To properly separate service charges and tips, employers should use a distinct earnings code for mandatory service charges when reporting payroll information.
Qualifying Occupations for Tip Reporting
Tip reporting applies to employees in roles where receiving tips is a regular part of the job. This generally includes food and beverage staff, hotel and hospitality employees, entertainers, personal care and wellness professionals, recreation instructors, and transportation or delivery workers. Identifying these roles helps ensure tips are accurately tracked and correctly reported on the W‑2.
How Payroll Technology Automates Tip Tracking
Payroll technology can help organizations manage tip tracking more efficiently, reduce manual errors, and support compliance with current regulations. These systems typically offer:
- Separate tracking capabilities: Platforms track cash tips, credit card tips, and mandatory service charges separately. Starting with the 2026 W‑2, listing tips will be mandatory, so this separation helps ensure accurate reporting and proper employee accounting of qualified tips.
- Integration with point-of-sale systems: Many payroll solutions integrate with restaurant and hospitality point-of-sale systems (POS) to capture tip data and transfer it to payroll records. This reduces manual data entry and the risk of errors.
- Real-time reporting: Automated systems provide visibility into tip income, allowing employers to monitor compliance and identify discrepancies early. This is especially useful for organizations with multiple locations or high employee turnover.
- Scalability: As businesses grow or regulations change, payroll systems can adapt to new earnings codes, reporting requirements, and calculation methods without disrupting operations.
Actionable Steps for Maintaining Compliance
Organizations can take the following steps to support compliance with OBBBA tip-related requirements:
- Assess current payroll systems: Regularly evaluate whether your payroll system tracks and reports tips and service charges separately. If it does not, consider solutions that support these capabilities.
- Use correct earnings codes: Maintain a separate earnings code for mandatory service charges and apply it consistently to support accurate payroll reporting.
- Train staff: Ensure payroll, HR, and management teams understand the difference between tips and service charges. Provide ongoing guidance on proper classification and reporting. Employees who receive tips should also understand how the criteria and what documentation to keep.
- Monitor IRS updates: Stay informed about additional IRS guidance related to OBBBA, including any changes to qualifying occupations or tax forms.
- Conduct system audits: Periodically review payroll processes to confirm they accurately track, categorize, and report tips and service charges. Address any issues promptly.
Protect Your Business and Simplify Tip Reporting with CBIZ
Leverage payroll technology and best practices by separating tip types and using proper earnings codes to maintain seamless compliance.
CBIZ streamlines payroll management and tip reporting while keeping your business compliant. Connect with our team today.
Frequently Asked Questions
OBBBA establishes that up to $25,000 in qualified tipped income may be exempt from federal income tax for employees and certain self-employed individuals.
Payroll technology automates tip management by using separate earnings codes to track different tip types for accurate W-2 reporting and integrates with point-of-sale systems to eliminate manual data entry.
Only tips are eligible for the OBBBA tax deduction.
- Tips: Voluntary payments customers give directly to employees.
- Mandatory service charges: Required fees added to a bill and treated as business revenue, not tips.
Correct payroll classification ensures accurate tax reporting and compliance.
© Copyright CBIZ, Inc. All rights reserved. Use of the material contained herein without the express written consent of the firms is prohibited by law. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein. Material contained in this publication is informational and promotional in nature and not intended to be specific financial, tax or consulting advice. Readers are advised to seek professional consultation regarding circumstances affecting their organization.
“CBIZ” is the brand name under which CBIZ CPAs P.C. and CBIZ, Inc. and its subsidiaries, including CBIZ Advisors, LLC, provide professional services. CBIZ CPAs P.C. and CBIZ, Inc. (and its subsidiaries) practice as an alternative practice structure in accordance with the AICPA Code of Professional Conduct and applicable law, regulations, and professional standards. CBIZ CPAs P.C. is a licensed independent CPA firm that provides attest services to its clients. CBIZ, Inc. and its subsidiary entities provide tax, advisory, and consulting services to their clients. CBIZ, Inc. and its subsidiary entities are not licensed CPA firms and, therefore, cannot provide attest services.
