Do you earn tips at a nail salon or restaurant? The federal government now exempts up to $25,000 a year — but your W-2 has to be right, and California still taxes it

What's going on?

In July 2025, Congress passed the federal tax law P.L. 119-21, widely known as the "One Big Beautiful Bill." It created two new deductions for workers: one for tips, one for overtime pay. Both apply to tax years 2025 through 2028, then expire unless Congress extends them.

A deduction is an amount subtracted from your taxable income. It is not a check from the government. Say a nail technician collects $14,000 in tips over the year. She can subtract $14,000 from her federal taxable income. At a 12% tax rate, that saves her about $1,680 in federal income tax. That figure only illustrates the math; actual savings depend on each household's income.

2025 is a transition year. According to the IRS, 2025 W-2s don't have to break out tips or overtime separately, and taxpayers work from their own records (IRS Notice 2025-69). Tax year 2026 is different. The IRS's 2026 W-2 instructions require every employer to report tips and overtime in three new places. The first W-2 in that format must reach employees by February 1, 2027.

This lands squarely on two of the Bolsa area's anchor trades. Nail technicians take tips in cash and by card. Servers at a phở shop pool tips by shift. Cooks and dishwashers get a share at the end of the night. All three fall under the new law, and the owner is the one who has to record it correctly.

Who qualifies, and which tips count?

Not every tip dollar qualifies. The IRS sets three conditions.

First, your occupation has to be on the list. Treasury finalized a list of 71 occupations in final regulations TD 10044, published April 13, 2026. Each has a three-digit Treasury Tipped Occupation Code. The ones you'll see around here:

• 605: manicurists and pedicurists
• 603: barbers, hairdressers, hairstylists and cosmetologists
• 601: skincare specialists
• 602: massage therapists
• 606: eyebrow and eyelash technicians
• 102: wait staff
• 101: bartenders
• 104: dining room and cafeteria attendants and bartender helpers (bussers)
• 105: chefs and cooks
• 106: food preparation workers
• 107: fast food and counter workers
• 108: dishwashers
• 109: host staff
• 110: bakers

Second, the tip has to be a real tip. The IRS calls these "qualified tips": money a customer gives voluntarily, in cash, by credit or debit card, or through a payment app, including amounts received through tip sharing. A charge the business adds to the bill doesn't count. Example: a restaurant adds an automatic 18% "gratuity" for a party of eight. Per the IRS, that is a service charge, meaning wages, not a tip. Tips paid in cryptocurrency don't count either.

Third, there are limits. The maximum deduction is $25,000 per return. It phases out for modified adjusted gross income above $150,000 ($300,000 for joint filers): for every $1,000 over the threshold, the deduction shrinks by $100. You need a Social Security number, and married couples must file jointly to claim it.

Social Security and Medicare taxes don't change. Per the IRS, tips of $20 or more in a month remain subject to both, as before. The new deduction only reduces federal income tax.

Self-employed workers qualify too if their occupation is on the list, such as a salon owner who does clients' nails herself. But there is an exception for certain specified service businesses (the IRS calls them SSTBs). Anyone who is both the owner and a tipped worker should ask a CPA before counting on the deduction.

The three new W-2 entries, decoded

Knowing you qualify is one thing. Whether your W-2 is filled out so you can actually claim it is another.

Per the IRS's 2026 General Instructions for Forms W-2 and W-3, look for three new things:

• Box 12, code TP: total tips you reported to your employer during the year, including cash tips, card tips and tips received through tip sharing.
• Box 14b: your occupation code. The employer enters up to two codes, based on the occupation or occupations in which the tips were earned. Code 000 means the tips came from a non-qualifying occupation and can't be deducted.
• Box 12, code TT: total federally qualified overtime pay. That is only the portion above your regular rate that federal law, the FLSA, requires. More on that below.

The old box 14 is renamed 14a and still holds the other items it always did.

An example. Ms. A works as a nail technician in Garden Grove. Her 2026 W-2 shows $38,000 in box 1 for wages and tips. Box 12, code TP, shows $14,000. Box 14b shows 605. When she files her federal return in spring 2027, she uses those two numbers on Schedule 1-A to figure the deduction. If box 14b showed 000, she could not deduct those tips.

The single most important point: tips you never reported to your employer never make it onto the W-2. Under IRS rules (Topic 761), an employee who receives $20 or more in tips in a month must report them to the employer by the 10th of the following month, on Form 4070, in the Form 4070A daily log, or through the business's own system. Unreported tips still have to be declared at filing time, along with the unpaid Social Security and Medicare tax, on Form 4137.

Overtime: the federal math is different from California's

The second deduction is for overtime, and this is where California workers are most likely to be misled.

Federal law, the FLSA, only requires overtime after 40 hours in a week. California requires more: after 8 hours in a day, on the seventh consecutive day of the workweek, and double time after 12 hours in a day. According to the IRS (fact sheet FS-2026-01), only the overtime the FLSA requires counts as "qualified overtime." What California adds on top does not qualify for the federal deduction. And only the "half" in "time and a half" counts.

Two examples:

• Mr. B works 10 hours a day, four days a week, 40 hours in total. California law pays him 8 hours of overtime. Under the FLSA he hasn't passed 40 hours, so there is no federal overtime. Federal deduction: $0.
• Ms. C works 8 hours a day, six days a week, 48 hours in total. The FLSA requires overtime on 8 of those hours. The "half" portion of those 8 hours is qualified overtime. She can deduct it, up to $12,500 a year ($25,000 for joint filers).

Employers have to separate the two kinds of overtime in payroll for the code TT figure to be right. Many small shops have never split them. That is a question to put to your payroll company this quarter.

And Sacramento? California still collects

Everything above is federal. The state return is a different story.

The Franchise Tax Board (FTB), California's state tax agency, wrote in its March 2026 analysis of Assembly Bill 1550 that state law has no comparable deduction for tips or overtime. In plain terms, Ms. A's $14,000 in tips still counts in full on her Form 540. FTB's February 2026 Tax News puts it more broadly: California does not conform to the One Big Beautiful Bill.

AB 1550, by Assemblymember Kate Sanchez, would have had California follow the federal rules for 2026 through 2028. The Assembly Revenue and Taxation Committee heard it on April 27, 2026 and held it without a vote. A Senate bill on tips, SB 984, was held in committee on May 14, 2026. So in the 2027 filing season, people in Little Saigon will see two different numbers: a federal deduction, and none for the state.

FTB has not yet published instructions on how the adjustment will appear on Schedule CA of Form 540 for 2026.

What owners should do before December 2026

None of this works unless the shop records things correctly starting now. Five steps, in order:

Step 1: Ask your payroll company. Ask directly: does the software have box 14b, code TP and code TT? Has each employee been assigned an occupation code? Nail technicians are 605, hairstylists 603, servers 102.

Step 2: Audit how tips are recorded. Are card tips split to technicians with a record? Do workers report cash tips monthly? If the shop pools tips by shift, write down who got what. No record means nothing to put on the W-2.

Step 3: Separate service charges from tips. An automatic 18% charge for a large party is wages. What the customer adds on the receipt is a tip. The two travel different paths on the W-2.

Step 4: Separate federal and California overtime. The ninth hour of a day is California. The 41st hour of a week is FLSA. Payroll has to know which is which.

Step 5: Calendar the W-2. Employees get their W-2 by February 1, 2027. Fix errors with a W-2c. File with the Social Security Administration by the same date.

Owners who aren't sure should talk to a licensed CPA or enrolled agent before closing out year-end payroll.

What workers should do

For technicians and servers, the to-do list is shorter, but it has to be steady.

• Report tips to your employer every month. $20 or more means you must. Keep your own log, on paper or in an app. It is your evidence if the W-2 comes up short.
• Look at your W-2 in February 2027. Is there a code TP in box 12? Is the code in box 14b correct? If anything is missing, ask your employer right away. Don't wait until April.
• Get your paperwork ready. You need a Social Security number. Married couples must file jointly to claim the deduction.
• Don't believe "tips are 100% tax-free." The federal deduction goes up to $25,000, but Social Security and Medicare are still withheld. And California still taxes tips.
• Be careful with preparers who promise big refunds. Use only a preparer with an IRS PTIN, or a licensed CPA or enrolled agent.

Bigger than one W-2

The tip deduction expires after tax year 2028 unless Congress extends it. Sacramento may follow the federal rules, through AB 1550 or another bill, or it may not. Both of those are out of Bolsa's hands.

What is in your hands is the W-2 that arrives in February 2027. For many technicians in this neighborhood, it will be the first time their tips appear as a clear number on an official document. Whether that number is right depends on how the shop keeps its records over the last three months of 2026. The owner decides when adjusting payroll. The worker decides by reporting tips in full every month.