CNBC recently reported on the topic that with the “no tax on tips” policy now in effect, many restaurants may be forced to reconsider their use of service fees for large groups. Mandatory gratuities—typically 15% to 20% for parties of six or more—do not qualify for the tax benefit under President Trump’s new law. Although the restaurant industry has pushed for broader tax relief on behalf of owners, the IRS has made it clear that only voluntary tips fall under the new policy, leaving little room for reinterpretation of Congress’s language.   

Many restaurants may need to revisit their mandatory gratuity policies if they want this income to qualify as “tips” under the new tax law. President Trump’s One Big Beautiful Bill Act includes a “no tax on tips” provision that allows eligible workers to deduct up to $25,000 in qualified tips annually from 2025 through 2028. However, mandatory gratuities—typically 15% to 20% added to large parties of six or more—do not count as qualified tips. This outcome is disappointing for the restaurant and foodservice industry, which had hoped for broader inclusion.

The stakes are significant: the restaurant industry is the nation’s second-largest private-sector employer, supporting 15.7 million jobs and accounting for 10% of the U.S. workforce, according to the National Restaurant Association. Mandatory service fees are also widespread. Research from the association shows that 54% of full-service operators—rising to 67% among fine-dining establishments—sometimes add service charges or automatic gratuities. Of those, 12% apply the fees to all checks, while 88% use them only for large parties, banquets, private events, or catering services.  

Notably, the Internal Revenue Service has never considered mandatory service fees as tips. However, the restaurant industry has not always adhered strictly to this rule.

According to Jean Hagan, a partner at Eisner Advisory Group, many proprietors were surprised to learn they had been incorrectly treating service fees as tips. “They’ve just always been doing it a certain way—passing on the service fees to employees as a tip,” Hagan explained during a recent industry webinar.

Now, restaurants face increased pressure to properly manage these funds. All tips must be processed through payroll, even if the restaurant was previously miscategorizing service fees. Hagan emphasized that restaurants “have to clean their systems up and follow the law as it’s always been.” Failure to do so means “the employee won’t get the full benefit of the new tax law [deduction].”  

Industry lobbying has so far fallen short   

Restaurant industry advocates have pushed for changes in how service fees are classified, hoping automatic gratuities could be treated as tips under the new law. The Culinary Union in Nevada formally urged the U.S. Treasury and IRS to consider both automatic gratuities and suggested tips as eligible tip income. Several Nevada members of Congress also appealed to Treasury Secretary Scott Bessent, arguing that workers should not be penalized simply because their employer uses a different tipping model.

“Functionally, for employees, there is no distinction between auto-gratuity and a tip,” lawmakers wrote in an August 12 letter, noting that excluding automatic gratuities creates arbitrary disadvantages for certain workers.

Despite these efforts, a policy shift appears unlikely. In September, the IRS released proposed rules for the “no tax on tips” deduction, and while not yet final, the guidance offers little flexibility. The OBBBA’s statutory language is explicit: tips must be voluntary. Andrew Lautz, director of tax policy at the Bipartisan Policy Center, told CNBC, “Congressional intent is pretty clear; what’s unclear is how restaurants respond to that.”

Business owners consider their next steps—and potential competitive impacts   

Many restaurants are adopting a wait-and-see approach as they await the IRS’s final rules on the “No Tax on Tips” provision. “Restaurant operators are watching closely for the final rules and will evaluate any shift in their tipping policies to best support their employees,” said Sean Kennedy, executive vice president of public affairs for the National Restaurant Association. He noted that workers choose restaurant jobs largely for the earning potential that tips provide, and owners want to ensure their staff can fully benefit from the new tax credit.

Others are already exploring potential changes. According to the Texas Restaurant Association, some operators are consulting with accountants, point-of-sale providers, and internal teams to determine the best policy for their business and employees.

Competitive pressures may also drive shifts in strategy. A spokesperson for the Florida Restaurant and Lodging Association pointed out that servers working in restaurants that rely on service charges or commission-based models could feel disadvantaged if they cannot access up to $25,000 in tax-free tips—particularly if competing establishments eliminate service fees and make their employees eligible for the full deduction.   

The IRS has provided preliminary guidance to restaurants on how to help their employees maximize the benefit of the new tips deduction  

Despite industry hopes, tax experts don’t expect the agency to loosen its stance that mandatory service fees do not qualify as tips. At an October hearing, the IRS reaffirmed that service charges remain ineligible, a position that is widely expected to hold in the final rules. 

In guidance released in September, the IRS outlined several ways restaurants can adjust their billing practices so that more payments count as voluntary tips. For example, an automatic 18% charge on large parties still wouldn’t qualify, but if a customer adds an additional voluntary amount—such as 2% in an “additional tip” line—that portion would. Likewise, restaurants can list an 18% “recommended tip” and allow customers to raise, lower, or zero it out; whatever amount the customer ultimately chooses is considered a qualified tip. The same applies to handheld POS systems that allow diners to select from preset tip options or choose no tip at all. 

As businesses navigate these rules, time is short. With President Trump’s new tax law taking effect and regulations still in progress, the IRS issued a safe harbor for 2025, ensuring employers won’t be penalized this year for not separately accounting for designated cash tips or employees’ job roles. However, this relief applies only for the 2025 tax year.

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