What "No Tax on Tips" Actually Means

Why 'no tax on tips' is not no tax

The "no tax on tips" law is a federal income-tax deduction on cash tips in customer-tipping jobs (servers, bartenders, hairdressers). The cap is $25,000 per tax return, phased out above $150,000 income, expires after 2028. Social Security and Medicare still apply.

It applies to voluntary cash tips customers choose to leave. It does NOT apply to mandatory service charges (auto-gratuities, banquet fees) or cryptocurrency tips. For employees, the benefit lands at tax filing, not paychecks. For 2026 W-2s, two new boxes: Box 12 code TP for cash tips, and Box 14b for the worker's occupation code. California, New York, and Illinois don't honor it at the state level — but Colorado does for tips, unlike for overtime.

What employers need to do for 2026 W-2s

• Audit your last pay period — are cash tips and service charges in different payroll categories?
• Pull the IRS occupation code for each tipped employee before the December plan-year close.
• Confirm your payroll vendor has installed the 2026 W-2 update for Box 12 code TP.
• Tell tipped employees: the benefit shows up at tax filing, not your next paycheck.
• For employees in CA, NY, or IL: state income tax applies to the full tip amount.

Where employers will mis-report this

• The 18% auto-gratuity from a party of 8 in Box 12 code TP — service charges aren't tips.
• Tips for a worker whose occupation isn't on Treasury's list — the bouncer who also takes coats.
• Box 14b left blank for a tipped server — the IRS may reject the worker's deduction claim.
• The $25,000 cap reported as the W-2 figure when the employee earned more in tips.

When in doubt, leave it out of Box 12 code TP

On the 2026 W-2, Box 12 code TP only counts cash tips passing three tests: the customer chose to leave them, the worker's job is on Treasury's list, and the worker is on your payroll. Miss any test, leave the tip out. The worker loses a small deduction; over-reporting costs you $310 per W-2.