2025 Tip Deduction  

The One Big Beautiful Bill Act (OBBBA), effective for tax years 2025 through 2028, introduces a significant new federal income tax deduction for individuals who receive tips in certain occupations. Below is a comprehensive summary of the treatment of tips under the OBBBA, including the new deduction, definitions, eligibility, reporting, calculation, and limitations.

1. New Federal Income Tax Deduction for Tips

Deduction Amount and Period

• Individuals (employees and self-employed) may deduct up to $25,000 per year of “qualified tips” received in eligible occupations.
• The deduction is available for tax years beginning after December 31, 2024, and before January 1, 2029 (i.e., tax years 2025–2028) [3].

Above-the-Line Deduction

• The deduction is “above-the-line,” meaning it reduces adjusted gross income and is available to both itemizing and non-itemizing taxpayers [2].

2. Definition of “Qualified Tips”

Statutory Definition

• “Qualified tips” are cash tips received by an individual in an occupation that customarily and regularly received tips on or before December 31, 2024, as determined by the Secretary of the Treasury [2].

Cash Tips

• Includes tips paid in cash, by check, credit card, debit card, gift card, or other electronic payment methods denominated in cash.
• For employees, also includes tips received through mandatory or voluntary tip-sharing arrangements (e.g., tip pools) [2].

Voluntariness Requirement

• Tips must be paid voluntarily, without compulsion, not subject to negotiation, and determined by the payor (the customer).
• Service charges, automatic gratuities, or other mandatory amounts added to a bill are not qualified tips unless the customer can freely disregard or modify the amount [2].

Exclusions

• Tips received in the course of a “specified service trade or business” (SSTB) as defined in IRC §199A(d)(2) are not qualified tips. This includes fields such as health, law, accounting, performing arts, consulting, athletics, financial services, and any business where the principal asset is the reputation or skill of one or more employees or owners.
• For employees, if the employer is an SSTB, tips received from that employment are not qualified tips, regardless of the employee’s specific duties [2].
• Tips received for illegal activities, prostitution, or pornographic activity are not qualified tips.
• Tips received from a payor in which the recipient has an ownership interest or is employed are not qualified tips [2].

List of Eligible Occupations

• The IRS, by regulation, has published a list of occupations that customarily and regularly received tips as of December 31, 2024. Only tips received in these occupations are eligible for the deduction. The list includes, but is not limited to, bartenders, wait staff, food servers, bellhops, hotel housekeepers, taxi/rideshare drivers, hairdressers, and casino dealers [2].

3. Eligibility Requirements

• The taxpayer must have a Social Security Number (SSN) and include it on the tax return.
• If married, the deduction is only available if the taxpayer and spouse file a joint return.
• For self-employed individuals, the deduction cannot exceed the net income (before this deduction) from the trade or business in which the tips were earned [2].

4. Reporting Obligations

For Taxpayers

• The deduction is claimed on the individual’s federal income tax return (Form 1040).
• The SSN of the individual who received the tips must be included.
• For self-employed individuals, the deduction is limited to the net income from the business in which the tips were earned [2].

For Employers and Payors

• Employers and other payors must file information returns with the IRS (or SSA) and furnish statements to taxpayers showing the amount of cash tips received and the occupation of the tip recipient.
• For 2025, due to transition relief, employers and payors may use any reasonable method to approximate the amount of tips and are not required to separately account for tips on Forms W-2, 1099-NEC, 1099-MISC, or 1099-K. The IRS will update forms for 2026 and later [1].

5. Calculation Methods for 2025

For Employees

• Use the total amount of social security tips reported in box 7 of Form W-2.
• Alternatively, use the total amount of tips reported to the employer on all Forms 4070 (Employee’s Report of Tips to Employer).
• If the employer voluntarily reports cash tips in box 14 of Form W-2 or on a separate statement, that amount may be used.
• Include any amount listed on line 4 of Form 4137 (Social Security and Medicare Tax on Unreported Tip Income) filed with the tax return [1].

For Non-Employees (Self-Employed)

• Use the total amount of tips included in the total reported as other income on Form 1099-MISC, nonemployee compensation on Form 1099-NEC, or payment card/third-party network transactions on Form 1099-K.
• If tips are not separately identified, use earnings statements, receipts, point-of-sale system reports, daily tip logs, or other documentary evidence to substantiate the amount of tips received [1].

Recordkeeping

• Taxpayers must maintain adequate books and records to substantiate both eligibility for and the amount of any deduction claimed [1].

6. Limitations and Phase-Outs

Annual Cap

• The deduction is limited to $25,000 per year, regardless of filing status [2].

Phase-Out

• The deduction is reduced by $100 for each $1,000 (or fraction thereof) by which the taxpayer’s modified adjusted gross income (MAGI) exceeds $150,000 ($300,000 for joint filers). MAGI is AGI plus any amount excluded under IRC §§911, 931, or 933 [2].

Self-Employed Limitation

• For self-employed individuals, the deduction cannot exceed the net income (before this deduction) from the trade or business in which the tips were earned [2].

Married Filing Separately

• The deduction is not available to married individuals filing separately [2].

Specified Service Trade or Business (SSTB) Exclusion

• No deduction is allowed for tips received in the course of a trade or business that is an SSTB, either as an employee of an SSTB or as a self-employed individual in an SSTB [2].

Other Exclusions

• No deduction for tips received for illegal activities, prostitution, or pornographic activity.
• No deduction for tips received from a payor in which the recipient has an ownership interest or is employed [2].

7. Transition Relief for 2025

• For tax year 2025, due to the lack of updated information reporting forms, both employees and self-employed individuals may use reasonable methods to determine the amount of qualified tips, as described above.
• The IRS will not enforce the SSTB exclusion for employees or non-employees in 2025 if the occupation is on the IRS list of customarily and regularly tipped occupations, pending further guidance [1].

8. Examples

• Employee: A restaurant server with $18,000 in box 7 of Form W-2 may deduct $18,000 as qualified tips, subject to the $25,000 cap and phase-out rules.
• Self-Employed: A travel guide who receives $7,000 in tips through a third-party platform and keeps a daily tip log may deduct $7,000, provided it does not exceed net business income [1].

9. Additional Notes

• The IRS has published a detailed list of eligible occupations and will update forms and instructions for 2026 and later years.
• Employers and payors must adapt payroll and reporting systems to comply with new requirements for 2026 and beyond [2].

In summary: The OBBBA provides a substantial new deduction for tips, but only for tips that are voluntary, received in IRS-listed occupations, and not in connection with a specified service trade or business. The deduction is subject to annual and income-based limitations, and both taxpayers and employers face new reporting and substantiation requirements, with transition relief for 2025 [2] [1] [3].