“No Tax on Tips”: What Tipped Workers Need to Know About the New Tax Deduction

Starting in 2025, The One Big Beautiful Bill Act (OB3) provides a new tax benefit for workers who receive tip income. While it’s widely referred to as “No Tax on Tips,” what it really does is create a significant federal tax deduction for eligible tipped workers, potentially lowering your taxable income and tax liability when you file your tax return.

What Is the “No Tax on Tips” Deduction?

This deduction allows eligible workers to subtract a portion of their tip income from their federal taxable income for tax years 2025 through 2028.

Unlike a full exemption (which would make tip income completely tax-free), this change is a deduction, meaning you still report all your tip income, but you’re able to exclude up to a certain amount from taxable income when calculating federal income tax.

Who Can Take the Deduction?

To qualify for the deduction:

• You must report your tips on your federal tax return, either through a Form W-2, Form 1099, or by reporting directly on a Form 4137. For 2025 the tips can also be reported as income on Schedule C.
• You must have a valid Social Security number on your return.
• Your tips must come from a job in an occupation that the IRS considers “customarily and regularly” receiving tips before December 31, 2024.
• You can claim the deduction whether you itemize deductions or take the standard deduction.

However, some individuals are not eligible:

• If you’re self-employed in a “Specified Service Trade or Business” (SSTB) under tax code Section 199A. However, this rule is waived for 2025 tax returns.
  • SSTB’s are businesses where the main value comes from the reputation, skill, or expertise of the owners or employees, rather than from selling products.
• Employees of businesses that are categorized as SSTBs, even if the worker is in a qualifying occupation. This provision is waived for 2025 tax returns.
• Married taxpayers must file jointly to claim the deduction.

How Much Can You Deduct?

The deduction has specific limits:

• Maximum Deduction per Year: up to $25,000 of your qualified tip income.
• Income Phase-Out: begins for higher-income taxpayers.
  • For single filers, it starts reducing once your modified adjusted gross income (MAGI) is over $150,000.
  • For married couples filing jointly, the phase-out starts at $300,000.

If your income keeps rising above those thresholds, the amount you can deduct gradually shrinks.

For self-employed workers, your deduction cannot exceed the net income you earned from your tipped business activity (before applying the deduction).

What Qualifies as a “Qualified Tip”?

Not all tip-like income counts, so here’s what qualifies:

• Voluntary tips: must be voluntary and paid by the customer, not automatically added service charges.
• Cash or cash-equivalents: cash, credit/debit card tips, checks, gift cards, etc. Cash tips do not include items paid in any medium other than cash, such as event tickets, meals, services, or other assets that are not exchangeable for a fixed amount in cash (such as most digital assets).
• Occupational requirement. You must earn your tips in an occupation on the IRS’s list of jobs that “customarily and regularly receive tips.” These jobs include beverage and food service, entertainment and events, hospitality and guest services, home services, personal services, personal appearance and wellness, recreation and instruction, and transportation and delivery.

What Doesn’t Qualify

• Mandatory service charges included on a bill. For example, if you’re a server at a restaurant and an automatic gratuity of 20% is added to the bill, this amount will not qualify for the deduction.
• Tips from occupations not on the IRS’s eligible list. Alas, accountants are not on the list of eligible occupations.
• Tips not reported on W-2, Form 4137, 1099-NEC, or as income on Sch-C (2025 only)
• Amounts received from illegal activities (obviously).

How to Claim the Deduction

When you prepare your 2025 tax return (filed in 2026):

1. Report all of your tip income, just as you always have.
2. Claim the tip deduction (up to $25,000) as an above-the-line deduction on Schedule 1-A, which reduces your adjusted gross income.
3. File jointly if you’re married, and make sure your income falls within the qualifying limits.

Note: For tax year 2025, employer reporting systems may not yet show tips separately on W-2s or 1099s – the IRS is providing transition relief while it updates forms and reporting procedures.

What This Means for Tipped Workers

For many workers in traditional tipping jobs, this deduction could lower your federal taxable income and reduce your tax bill, helping you keep more of what you earn. However, it’s important to remember:

• You still report all of your tip income.
• The deduction applies only to federal income tax – payroll taxes (Social Security, Medicare) still apply as before OB3. State rules vary.
• The change is temporary, lasting only through tax year 2028.

Bottom Line

The “No Tax on Tips” provision offers a new way for eligible tipped workers to reduce their federal tax burden between 2025 and 2028. By understanding the rules – who qualifies, how much you can deduct, and what counts as “qualified tips” – you can take full advantage of this change and possibly keep more of your hard-earned money.

Need help determining if your job qualifies or how to report your tips correctly? Contact us today!

The information provided in this article is intended for general informational purposes only and does not constitute tax, legal, or financial advice. Tax situations vary based on individual circumstances. You should consult with a qualified tax professional regarding your specific situation before making any decisions.