Challenges with Tip Income Deduction, Particularly for 2025

I've blogged already on the inequities of the tip income deduction (9/10/25 post).  It also has some recordkeeping and compliance challenges for employers and employees, and payors and contractors. These challenges will be greater for 2025 because tipped workers won't have their qualified tips separately reported on their W-2, or 1099-NEC or 1099-K. That won't happen until 2026.

Recently, the IRS provided relief to employers and 1099 filers for 2025 because otherwise they could face penalties for not reporting the qualified tips. The IRS does encourage employers and others to find some way to get information to employees on their qualified tip amount and occupation code, such as via a written statement or online portal (see IR-2025-110 and Notice 2025-62).

Now you might think, don't tipped workers know how much their tip income is?  Well, they might, but do they know what their "qualified" tip amount was?  They are not the same thing!

For example, the following are tips, but not qualified tips that will generate a deduction for the worker.

• Tip received by a waiter at a restaurant but it was automatically added to the bill such as because it was a party of 6. This is not voluntarily paid so is not a qualified tip, even if the restaurant gave it to the waiter.
• The employee works for an employer who is a "specified service trade or business" (SSTB), such as theater or other performing arts business. This might also be confusing for employees with multiple jobs. For example, the bartender employee at the restaurant gets qualified tips (if paid voluntarily), but when she works at the performing arts center as an employee, those tips are not qualified.
• The worker might not be in one of the many listed occupations per a table in the proposed regulations (§1.224-1 at REG–11003225 (9/22/25)). The IRS says it will have the lists at this website, but it is not operational at 11/15/25 - https://www.irs.gov/TippedOccupations. 
• The tipped worker is an independent contractor such as a gardener without a 1099. Their tips are only qualified if they are reported on a Form 1099-NEC or 1099-MISC or 1099-K. If the gardener works for households and gets paid in cash, they won't get a 1099.  If they do work for businesses, they will get a 1099-NEC for 2025 if paid $600 or more. I'm assuming the contractor reports all income including the tips.  As soon as they can, contractors who don't get a 1099, such as because paid in cash by households, they should start taking credit or debit card or PayPal or Venmo so they will get a 1099-K.  We still don't know how PayPal and Venmo will get the tip info, likely they will be required to have the payor specify these amounts.

There is a lot of work here, particularly for the issuers of the W-2 and 1099s.  For example, one example in the proposed regulations is a restaurant where the point of sale machine only offers 3 options on tips:15%, 18% and 20%.  Since there is not an option to put in your own number including zero, this is not voluntary. BUT, since 15% is the minimum in this scenario, if someone tips 18% or 20%, that differential is a qualified tip!  Of course, the restaurant or other establishment with this fact pattern will need to have its recordkeeping system set up to capture this.

Payors will definitely want to get recordkeeping systems ready very soon to be ready to report qualified tips on reporting forms. They might also want to see about changing customer billing arrangements to ease compliance, by, for example, making all tip amounts voluntary.

What do you think?