The deduction belongs to the employee, but the paperwork is yours. For tax years after 2024 and before 2029, individuals can deduct up to $25,000 of qualified tips. For 2026 Forms W-2 you have to report total cash tips in box 12 using new code TP, and identify the employee's tipped occupation. Mandatory service charges are not qualified tips, which is where most restaurants will get it wrong.
In this article
01What changed, in one paragraph02Why this is a point of sale problem before it is a payroll problem03What do I actually have to do before January?04What about the tip credit? Does this change my wage math?05Common questions your staff will ask, with straight answers06Questions restaurant owners askWhat changed, in one paragraph
Employees who receive tips can deduct up to $25,000 of qualified tips per year, for tax years beginning after 2024 and before 2029, with the deduction phasing out at higher incomes. It reduces federal income tax only. Social Security and Medicare still apply to those tips, and so does Arkansas income tax unless the state says otherwise.
For employers, the change is reporting. The 2026 Form W-2 instructions add box 12 code TP for the total cash tips reported to you, and Treasury has published the list of occupations that customarily and regularly received tips before the end of 2024.
Why this is a point of sale problem before it is a payroll problem
Payroll reports what you hand it. If your system has been posting automatic gratuities to the tip line, those amounts are sitting in your tip totals right now, and they are not qualified tips.
Mandatory service charges are explicitly excluded. A twenty percent auto-gratuity on a party of ten is a service charge, no matter what the receipt calls it or which line it printed on.
So the failure runs like this. The POS blends service charges into tips. Payroll picks up the blended number. Box 12 code TP overstates qualified tips. Your staff file returns claiming a deduction on money that does not qualify, and the correction lands on them, from you, at the worst possible moment.
Fixing it is a configuration job that takes under an hour. Finding it after the W-2s go out is not.
What do I actually have to do before January?
Five things, in this order. Separate service charges from tips in the POS and confirm it on a live ticket, not in the settings screen. Confirm every tipped employee is coded to a listed tipped occupation in your payroll records. Check that tip declarations at clock-out are flowing through cleanly. Run a trial W-2 in November and look at box 12 rather than trusting it in January. And tell your staff what the deduction is and, more usefully, what it is not.
That last one is worth real effort. Your team will hear about this from social media before they hear it from you, and most of what circulates says tips are now tax free. They are not. Federal income tax on qualified tips up to a limit, yes. FICA, no. Getting ahead of that conversation buys you a lot of goodwill.
A real person calls you back within two hours, Monday to Saturday, 8am to 7pm Central.
What about the tip credit? Does this change my wage math?
No. This is an income tax deduction on the employee's return. It does not change the Arkansas tipped cash wage of $2.63, it does not change the $11.00 state minimum, and it does not change your obligation to make up the difference when tips fall short.
It also does not change FICA. You still withhold and match Social Security and Medicare on tips as before.
Treat the wage math and the tax deduction as two separate systems that happen to share a word.
Common questions your staff will ask, with straight answers
Are my tips tax free now? No. You may be able to deduct up to $25,000 of qualified tips from federal income tax, subject to income limits. Social Security and Medicare still come out.
Does the auto-grat from that big party count? No. Mandatory service charges are not qualified tips.
Will I see more in my check each week? Not automatically. This is a deduction taken on a tax return, though withholding may be adjusted. Point them at a tax preparer rather than guessing for them.
Print the answers and put them in the break room. It costs you nothing and it prevents a month of hallway rumours.
Questions restaurant owners ask
What is box 12 code TP?
A new code on the 2026 Form W-2 used to report the total amount of cash tips an employee reported to you. It exists so the IRS can identify qualified tips for the deduction. If your tip totals include service charges, this box will be wrong.
Do mandatory service charges count as qualified tips?
No. IRS guidance is explicit that mandatory service charges added to a bill are not qualified tips. This is the single most likely source of error for restaurants, because many point of sale systems post auto-gratuity straight to the tip line unless somebody configured them otherwise.
Does the deduction remove Social Security and Medicare on tips?
No. The deduction reduces federal income tax only. FICA still applies to tips, for the employee and for your matching share. Anyone telling your staff that tips are now completely untaxed is wrong, and it is worth correcting early.
How much can an employee deduct?
Up to $25,000 of qualified tips, for tax years beginning after 2024 and before 2029, with the deduction phasing out for higher modified adjusted gross income. The exact phase-out depends on the individual's return, which is a question for their tax preparer and not for you.
Which of my employees qualify?
Those in occupations that customarily and regularly received tips on or before 31 December 2024, per the list Treasury and the IRS published. Most front of house roles are on it. Check your payroll occupation coding against the published list rather than assuming.
Is this tax advice?
No. It is a description of a reporting obligation, written so you can brief your accountant and your payroll provider properly. Rules and thresholds change and the details turn on your specific situation. Confirm before you file anything.
Vendor pricing and tax rates change without notice. Confirm current figures with the vendor, the city or your accountant before you rely on them. Not tax, legal or accounting advice.
Every number on this page traces to a primary source
- IRS guidance on the no tax on tips deductionirs.gov
- 2026 Form W-2 instructions, box 12 code TP for cash tipsirs.gov / iw2w3
- Treasury list of occupations that customarily and regularly receive tipsfederalregister.gov
- Arkansas minimum wage, tipped cash wage, deduction limits and overtimelabor.arkansas.gov / minimum wage and overtime