2025 Restaurant Tip Law Changes Explained (And How to Stay Compliant)
If you run a restaurant, bar, or brewery, 2025 brought one of the biggest changes to tip reporting in years and it comes with real financial consequences.
The new federal tip income deduction lets employees deduct up to $25,000 of their reported tips from taxable income. At the same time, restaurant owners can still claim the ongoing FICA Tip Credit (Form 8846) on the employer taxes they pay on those tips.
However, both of these benefits depend on one thing: ACCURATE REPORTING.
If your POS or payroll system is misclassifying tips and service charges, or if you’re assuming it’s doing the job correctly, you could be missing out on thousands of dollars in credits while exposing yourself to IRS penalties.
The 2025 Tip Deduction Is Great News, Only If You Report Correctly
The new federal deduction allows tipped employees to exclude up to $25,000 of tip income from their federal taxable income between 2025 and 2028. It’s a huge win for servers, bartenders, and barbacks, but only if their employers report tips correctly.
That means every dollar has to be recorded in the right category from the start. The IRS draws a firm line between tips and automatic gratuities (like banquet fees or large-party service charges).
When you blur that line, two problems would occur during an audit:
- Your employees would lose part of their deduction if their “tips” are really auto-gratuities showing up as wages.
- You would lose part of your form 8846 FICA Tip Credit. That’s the credit that reimburses you for the employer share of Social Security and Medicare taxes on reported tips.
So before your next payroll run, it’s worth asking: are our systems recording these correctly?
Also read: Cash Tips vs. Credit Card Tips: What’s Reportable and What’s Not in 2025
Step 1: Review How Your POS Handles Tips And Auto-Gratuities
Your POS system is the first line of defense in accurate reporting. Every transaction that includes a tip or service charge starts here and this is where most misclassifications happen.
The issue is that while most POS platforms do track and report tips and auto gratuities, not all of them do it correctly. That’s a problem because:
- Voluntary tips should stay labeled as tips. They get reported as “tips” for payroll, and qualify for both the employee deduction and your Form 8846 FICA Tip Credit.
- Automatic charges like auto-gratuities (for banquets, catering, or large tables) must be treated as wages and DO NOT qualify for either the employee deduction nor the form 8846 FICA Tip Credit.
If your POS reports everything under one “tips” line, your payroll will end up misreporting it and that’s on you, not the software.
Before year-end, sit down with your POS reports and make sure you understand exactly how it codes these categories. If “service charges” or “auto-gratuities” are being lumped in with tips, that’s a red flag.
Also read: How to Track Tips Correctly Across Your Restaurant’s POS and Payroll
Step 2: Review How Tips And Auto-Gratuities Are Reported In Payroll
The second critical step is to confirm how your payroll system receives and classifies this data. Many restaurant owners assume their POS-linked payroll program handles it correctly, but it usually doesn’t.
Since auto-gratuities must be reported as wages and are subject to standard payroll tax rules, these have to be captured separately from voluntary tips in your payroll system.
If your payroll system isn’t separating them, you’re effectively reporting incorrect tips & wage data to the IRS, which means you’re overstating or understating taxes, and that’s a serious compliance risk.
The IRS has been clear that relying on technology is not a defensible position in an audit. That means saying “that’s how my POS & Payroll program records it” will not hold up. You, restaurant owner, are responsible for verifying that the data is right before you file.
These POS and payroll programs have the ability to do it correctly, but they don’t do it automatically, as they rely on you, the business owner, to map everything correctly.
We have seen this firsthand with our restaurant clients. Even large, well-known POS/payroll platforms often default to the wrong settings; that’s why it’s critical to review your mappings and reports manually.
Why Proper Reporting Protects You
Getting your tip reporting right does more than keep the IRS happy, it directly impacts your bottom line. Here’s how:
You preserve your FICA Tip Credit (Form 8846)
This credit lets you recover the employer portion of Social Security and Medicare taxes you’ve paid on reported tips. If your records aren’t clean, you can lose thousands in credits you’ve already earned. By the way, please, please open your business tax return and look for Form 8846 to see if you are claiming this credit. It is a highly overlooked and missed tax credit.
You protect your employees’ new $25,000 tip deduction
If you misclassify auto-gratuities as tips, your staff could potentially lose some of the benefit and that’s a tough conversation to have after the fact.
You avoid penalties and back taxes
Misreporting can trigger fines, reclassifications, and interest charges from the IRS. And because POS and payroll systems retain digital trails, it’s easy for auditors to spot mismatches, really easy.
We’ll Help You Get Your Tip Credit & Stay Compliant
The 2025 restaurant tip law changes can really benefit employees but only if you’re reporting everything accurately. Between the new federal tip income deduction and the ongoing FICA Tip Credit, there’s real money on the line for both you and your team.
At U-Nique Accounting, we specialize in helping restaurants, bars, and breweries make sense of these exact issues. We’ll advise you on how to reconcile your POS and payroll data, ensure every tip is classified correctly, and confirm you’re claiming the maximum FICA Tip Credit available. We also utilize Xero to record your POS data on a daily basis and track and report your tips and auto gratuity service charges correctly so it aligns with proper payroll reporting, and reports your labor costs accurately so we can utilize Xero’s powerful custom reporting to track and report your labor costs, food costs vs food sales, beverage cost vs beverage sales, and many other meaningful ratios.
If you want peace of mind heading into 2025, schedule a free discovery call. We’ll help you clean up your reporting so you can stay compliant, confident, and credit-ready.
By MATT CIANCIARULO
