Zero Tax on Tips: What Restaurant Workers and Employers Need to Know
ST. LOUIS, MO (StLouisRestaurantReview)– In a significant shift for the U.S. restaurant and hospitality industry, the newly enacted “Tax-Free Tips Act of 2025” has removed federal income tax obligations on employee tips, effective July 1, 2025. The change is one of the most significant labor tax reforms in recent history, promising relief for millions of service industry workers across the country, especially restaurant staff who rely on gratuities as a substantial part of their income.
This article explains the key details of this new policy, its legal implications for payroll reporting, and how restaurant owners and employees in St. Louis—and nationwide—should adapt.
What Is the Zero Tax on Tips Law?
The Tax-Free Tips Act of 2025, passed as part of the broader Middle-Class Economic Relief Bill, exempts gratuities (aka tips) from federal income taxation starting July 1, 2025. Under this new policy:
- Tipped income is no longer subject to federal income tax.
- However, tips are still subject to Social Security and Medicare taxes (FICA).
- Employers are still required to report tips for compliance and payroll purposes.
The aim is to ease the tax burden on tipped workers—especially waitstaff, bartenders, and others in the hospitality industry—who often operate on modest base wages and depend on tips to earn a livable income.
When Did the Policy Begin?
The tax-free status on tips took effect on July 1, 2025, midway through the calendar year. Therefore, all tips received on or after July 1, 2025, are exempt from federal income tax. Tips earned before this date remain taxable under the previous regulations.
This mid-year implementation has confused restaurants and their workers, which is why understanding how to properly report and differentiate tip income before and after July 1 is crucial for payroll accuracy and legal compliance.
What Counts as a “Tip” Under the New Law?
The IRS defines tips as voluntary payments made by customers to employees in recognition of services provided. Tips can come in several forms:
- Cash tips (handed directly to employees)
- Credit/debit card tips
- Tips received through third-party platforms (like delivery apps)
- Shared tips or pooled gratuities
Mandatory service charges or automatic gratuities (e.g., a 20% charge for large parties) do not count as tips under IRS guidelines and are still taxable as regular wages.
Do Employees Still Have to Report Tips?
Yes, employees are still required to report tips to their employer. The reporting threshold remains $20 or more in a calendar month from a single source of income. Even though federal income tax no longer applies, the IRS mandates accurate reporting for the purposes of:
- Social Security and Medicare taxes
- Record-keeping for future benefits (like Social Security or disability)
- Employer tip credit eligibility
Failure to report tips can jeopardize employee benefits and employer compliance.
How Employers Should Handle Tip Reporting and Payroll
Although federal income tax on tips has been eliminated, employers must still adhere to best practices and IRS guidelines. Here’s what restaurant owners in St. Louis and across the country need to do:
1. Collect Tip Reports from Employees
Employees must submit a monthly tip report—typically via IRS Form 4070 or integrated POS/payroll systems—detailing total tips received. This ensures employers can accurately report FICA taxes.
2. Calculate and Withhold FICA Taxes
Employers are responsible for withholding Social Security (6.2%) and Medicare (1.45%) from reported tips. These taxes apply to all tips, even if they’re exempt from federal income tax.
3. Reflect Non-Taxable Tips on Pay Stubs
Payroll systems should now differentiate between taxable wages and non-taxable tip income. Most major payroll software (such as QuickBooks, ADP, or Gusto) has been updated or is rolling out updates to reflect this change. Non-taxable tips should be listed separately on pay stubs.
4. Do Not Withhold Federal Income Tax on Tips Earned After July 1, 2025
Employers should adjust their payroll systems to stop withholding federal income tax on tips received after July 1, 2025. Any failure to implement this change could result in over-withholding and payroll errors.
5. Maintain Accurate Records
Maintain thorough payroll records, including:
- Total tips reported by employees
- Breakdown of pre- and post-July 1 tips
- FICA tax calculations
- Adjustments in payroll tax filings
Example: How to Report Tips on Payroll (Post-July 1)
Let’s say a server earns:
- $800 in base wages
- $1,000 in tips (all after July 1)
Here’s what the payroll breakdown should look like:
| Category | Amount |
|---|---|
| Base Wage (Taxable) | $800 |
| Tips (Non-taxable) | $1,000 |
| Federal Income Tax | Applied to $800 only |
| Social Security Tax | Applied to $1,800 (wages + tips) |
| Medicare Tax | Applied to $1,800 (wages + tips) |
The $1,000 in tips will be included in gross income for FICA but excluded from federal income tax withholding.
Do State and Local Taxes Still Apply?
Yes—state and local tax treatment may vary.
As of this writing, Missouri has not yet updated its tax code to mirror the federal policy. Therefore, in Missouri—including St. Louis—tips may still be subject to state income tax unless the Missouri General Assembly enacts similar reforms.
Restaurant owners and employees should consult with their tax professional or the Missouri Department of Revenue for the most up-to-date guidance.
How This Impacts the Restaurant Industry
This tax reform brings a variety of benefits and considerations for the restaurant industry:
For Employees:
- More take-home pay without an increase in hours
- Less tax paperwork and complexity
- Incentive to work in tipped positions
For Employers:
- Potentially improved employee retention and morale
- Administrative adjustments to payroll and reporting systems
- Opportunity to attract top talent with more favorable compensation models
Restaurants that emphasize compliance and employee education will be better positioned to succeed in this new environment.
IRS Guidelines and Official Resources
The IRS has provided initial guidance through its official channels, including:
- IRS Publication 531 (Reporting Tip Income)
- IRS Notice 2025-41, which details the implementation of tax-free tips under the Tax-Free Tips Act
Employers should monitor the IRS website or consult with certified payroll professionals for additional compliance updates.
Final Thoughts: A Win for Workers, With Responsibilities
The implementation of tax-free tips is a major win for servers, bartenders, and hospitality workers. For a city like St. Louis, known for its thriving and diverse restaurant scene, this policy could mean more competitive earnings and higher job satisfaction.
However, both employees and employers have a legal duty to report tips and pay applicable FICA taxes accurately. Transparency and compliance will be key to avoiding penalties while maximizing the benefits of this policy change.
Refer to STL.News article about the Zero Tax on Tips.
Legal Disclaimer:
This article is for informational purposes only and does not constitute legal or tax advice. Readers are encouraged to consult with a licensed tax professional or accountant regarding their individual or business tax obligations.
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