The legislation known as One Big Beautiful Bill Act of 2025 (OBBBA) introduces a major change to how tip income is treated for federal tax purposes. Starting with tax year 2025, legislation allows eligible workers to deduct up to $25,000 in reported tip income from their federal taxable income.

Here’s a breakdown of what the law states, who qualifies, who doesn’t, and what tax professionals should consider when advising clients.

Key provisions of the no tax on tips

• Annual deduction limit: Maximum annual deduction is $25,000; for self-employed, deduction may not exceed individual’s net income (without regard to this deduction) from the trade or business in which the tips were earned

• Eligibility:

  • By Oct. 2, 2025, the IRS must publish a list of occupations that “customarily and regularly” received tips on or before Dec. 31, 2024. Examples likely include waiters, bartenders, hotel bellhops, casino dealers, hairdressers, and other similar service roles.
  • The deduction only applies to cash or card-based tips that you received from customers or through tip sharing in qualifying jobs. Service charges, regular wages or non-cash rewards are not considered qualified.
    • Adjusted gross income (AGI): $150,000 for single filers
    • $300,000 for married filing jointly

• Timeframe: applies to tax years 2025 through 2028

• Phaseout formula: the deduction is reduced by $100 for each $1,000 by which the taxpayer’s modified AGI exceeds the threshold.

• Employer reporting requirement: Tips must be reported to the employer and shown on Form W-2 or Form 1099 to qualify for the deduction.

Special focus: cash tips must be reported

Cash tips are often overlooked or underreported. Under this law, failure to report means loss of the deduction. Tips must be reported to the employer and included on statements furnished to the individual under IRC §6041(d)(3), §6041A(e)(3), §6050W(f)(2), or §6051(a)(18), or reported by the taxpayer on Form 4137.

Additional provisions

• Social Security number requirement: The taxpayer must include their Social Security number on the return to claim the deduction.
• Joint filers: Both spouses must file jointly to claim the deduction if married.
• Anti-abuse rules: The secretary is authorized to issue regulations to prevent reclassification of income as tips and to prevent abuse of the deduction.

What doesn’t count?

Not all payments received by service workers are eligible for the new tip income deduction. Tax professionals should be aware of the following exclusions:

• Unreported cash tips
• Tips not listed on the W-2 or Form 1099
• Service charges

Example: At a restaurant, Jamel’s bill includes a 15% service charge automatically added because he is part of a large group. He pays the total with his credit card. Even though it looks like a tip on the receipt, it’s a mandatory fee and not eligible for the tip income deduction. His server is Josh; therefore, Josh cannot count the 15% service fee as a tip.

There’s an income phaseout

The deduction is subject to an income-based phaseout. For every $1,000 (or fraction thereof) by which the taxpayer’s modified adjusted gross income MAGI exceeds $150,000 ($300,000 for joint filers), the deduction is reduced by $100.

Considerations for tax pros

1. Review client records

Advise clients in tip-based occupations to maintain accurate, contemporaneous records of all tips received and reported. Consistent tracking throughout the year is essential.

2. Confirm W-2 accuracy

Make sure client’s W-2s accurately reflect total reported tips. If clients have unreported tips , they must file Form 4137 to pay the appropriate FICA taxes. Remember, these unreported tips are not eligible for the deduction.

3. Withholding adjustments

Help clients estimate proper withholding or estimated quarterly tax payments based on the lower taxable income from the deduction.

4. Audit risk and compliance

Be alert to any attempts to reclassify wages as tips. Document legitimate tip income clearly to reduce audit risk.

5. Advise employers

Update payroll systems to ensure tips reported by employees are correctly captured. Businesses in the personal care sector may now benefit from an expanded FICA tip credit.

Final takeaway

The new tip deduction offers tax savings to lower- and middle-income workers, but only if they correctly report all tips to their employer. Tax professionals should ensure clients know the rules and follow them closely to benefit from this provision.