Preparing Payroll for the No Tax on Tips Act

On July 4, 2025, President Donald Trump signed H.R. 1, also known as the “One Big Beautiful Bill,” into law. At nearly 900 pages, this comprehensive legislation included the No Tax on Tips Act, which significantly changes how tips are taxed in America.  

With this law in effect and its impacts retroactive to January 1, 2025, payroll professionals must understand its implications and prepare their systems for compliance.  

This guide will help you navigate the No Tax on Tips Act’s key provisions and implementation requirements. 

Key provisions of the No Tax on Tips Act 

The No Tax on Tips Act allows eligible service workers to deduct up to $25,000 in annual tips from their federal taxable income. However, several important criteria determine who qualifies and what counts. 

Eligibility requirements 

To qualify for the tip deduction, employees must: 

• Work in positions that customarily receive tips as of December 31, 2024. The Treasury Department has 90 days from the passage of the legislation to publish an official list of qualifying occupations, but these positions typically include hospitality, transportation, and personal services roles. 

• Earn less than $150,000 in the prior tax year. For married couples filing jointly, this threshold increases to $300,000. 

Deduction details 

Though the No Tax on Tips Act wasn’t signed into law until July 4, its effects are retroactive to January 1, 2025. This means employees can claim the deduction for tips already earned this year. 

Payroll professionals should also note that this temporary provision expires after the 2028 tax year and only applies to federal income tax. Medicare and Social Security taxes still apply to all tip income.  

Additionally, all existing tip reporting requirements remain in place, so employees must continue reporting their tips as always. 

Qualifying tips 

Not all gratuities qualify for the deduction. Eligible tips include: 

• Cash tips 

• Credit card tips 

• Check tips 

• Tips from pooling arrangements (when properly reported) 

The following do not qualify: 

• Non-cash tips (gift cards, tickets, etc.) 

• Service charges 

• Unreported tips 

• Mandatory gratuities 

Related overtime provision 

The legislation also includes a separate overtime deduction that follows similar principles. 

Employees can deduct $12,500 annually for qualified overtime pay, or $25,000 for married couples filing jointly.  

This deduction applies only to overtime qualified under the Fair Labor Standards Act (FLSA) and covers only the premium pay portion, not base wage components. 

Like the tip deduction, this benefit is subject to the same income threshold of $150,000 (or $300,000 for married filing jointly). 

How payroll teams can prepare 

Since the law applies retroactively to January 1, 2025, payroll teams must address current processes and historical data from the first half of the year. 

Step 1: Determine employee classification and eligibility 

Begin by identifying which positions in your organization qualify for the tip deduction. Review these roles against the federal government's December 31, 2024, criteria to ensure they meet the requirements for customarily receiving tips. 

Once identified, you'll need to create a way of tracking these traditionally tipped positions and develop processes to monitor employee income against the $150,000/$300,000 threshold limits throughout the year. 

Step 2: Review system and technology readiness 

Next, evaluate your payroll infrastructure to ensure it can handle the new requirements, like the ability to process historical adjustments. For Workday customers, you may also need to configure your system to track and report on tips and deductions. You'll also need to program phase-out calculations to apply income thresholds automatically. 

Step 3: Confirm reporting and compliance infrastructure 

While your system handles the calculations, you’ll need to implement additional tracking mechanisms for tips and overtime deductions. For example, you’ll need comprehensive audit trails to monitor compliance with the $25,000 tip and $12,500 overtime limits. This means documenting eligibility determinations, tracking cumulative deduction amounts, and maintaining clear records of any retroactive adjustments.  

Don't forget to create documentation processes that can support retroactive compliance for the 2025 tax year, as you'll need to show how you applied the law to earnings from January forward. 

Step 4: Communicate changes effectively 

Clear communication is essential for smooth implementation across your organization. This means educating employees about which tips qualify for the deduction and reinforcing proper reporting requirements. Be clear about how the retroactive application works and what it means for their 2025 taxes. You should also provide guidance on maximizing their benefits while staying within legal limits, and be prepared to address questions about why the deduction applies only to federal taxes and not state taxes or FICA. 

Looking ahead 

The Treasury Department will release additional guidance and clarifications in the coming months, including the official list of qualifying occupations by October 2, 2025. In the meantime, payroll teams should prepare for these updates while building scalable solutions for the 2025-2028 tax years. 

As you navigate these changes, remember that this legislation represents both an opportunity for your employees and a compliance requirement for your organization. Taking proactive steps now will ensure smooth implementation and help your eligible employees maximize their tax benefits. 

Need assistance implementing these changes? We’re committed to helping Workday customers navigate and understand the complexities of payroll compliance. Contact us to discuss how we can support your team.