The One Big Beautiful Bill Act (OBBBA) makes tip income tax-free. But as with any new tax law, the fine print matters, and some of these details still need clarification.
Here is what you should know.
The Basic Facts
From January 1, 2025 through December 31, 2028 you can deduct up to $25,000 as a deduction equal to the amount of qualified tips you receive during the year. These tips must be included on IRS approved statements furnished to the individual in order to take advantage of the deduction.
There is an income limit of $150,000 for single filers and $300,000 for joint filers. This income limit is modified adjusted gross income, including the tips. The deduction amount is reduced (but not lower than zero) by $100 for each $1,000 in excess of these amounts.
Qualified Tips
To qualify as a tip:
- The tip must be given in the ordinary course of business
- It must be paid voluntarily
- Is not subject to negotiation
- It is determined by the payer
What business and services qualify?
A list of qualifying business will be published on or before December 31, 2025, however the tax bill specifically mentions the following:
- Food & beverage for consumption, if tips are customary
- Barbering & hair care
- Nail care
- Esthetics (services like Body and Spa Treatments)
Of special note, if you work in a specified service trade or business (SSTB) you MAY NOT take the tip deduction. A SSTB is a type of business that provides services in fields such as health, law, accounting, consulting, and financial services,
The Fine Print Matters
To receive the deduction:
- It must be reported. This means this tip income will ultimately end up on a W-2. This means you must have a valid Social Security number.
- They must be cash. The IRS defines cash to include cash, credit card, debit card, and digital payment tools. This then implies that any non-cash tips and receipt of cyber currencies would not qualify.
- It will still be taxed (somewhat). While you will receive a tip deduction on your tax return, that tip income will still be subject to Social Security and Medicare taxes.
- You must have income. The deduction will reduce your taxable income. But if your taxable income is already at or below zero (because of other tax breaks like the standard deduction) there really is minimal to no benefit for this new deduction.
- If married, file jointly. The benefit does not exist for married filing separately.
- Tip behavior cannot be created. If your employer did not customarily make tips prior to this law, they cannot suddenly start tip behavior to take advantage of the benefit.
What Action to Take
If you think you may qualify for this deduction, here are some tax tips to consider:
- Get your reporting in order. Remember it's already mid-year. You'll need to prove your tips to get this deduction. So start getting your tip records in order, then you can reconcile your tip income with your employer’s reporting of your tips.
- The large-party tip. Many restaurants add an automatic tip when a dinner party is larger. On the surface the bill seems to exclude these tips from the deduction because the tip is no longer voluntary. Until there is clarification, it might make sense to get your employer to consider an alternative practice or figure out how to confirm the voluntary nature of such a tip.
- Your tips are not covered! There are a large number of jobs that regularly receive tips that are not mentioned in the bill. Bell hops, cabbies & uber drivers, and delivery jobs to name a few. Do not lose heart, as the IRS is tasked with figuring out which jobs should be included but won't have to do so until on or before the end of the year. Hopefully it will be completed within 90 days.
- Cash not reported. If you receive cash but it's not reported, it can't be used as a deduction. So do the math for your situation and consider properly recording this tip income.
- Patience is required. There will be clarification of these rules from the IRS within the next 90 days. So even if your tip income is not expressly included as of now, still keep track of it as it could easily make the IRS’s list.
Congress is very aware that there will be the temptation to reclassify taxable income into tip income to take advantage of this law change, so it's tasking the IRS to develop guidelines to keep this from happening. Stay tuned. There is more to come.