Starting in tax year 2025, the One Big Beautiful Bill Act (OBBBA) introduces a valuable tax deduction for workers who receive tips. While tips have always been considered taxable income subject to both income and employment taxes, this new legislation offers some relief for qualifying individuals.
What’s Changing?
Under the OBBBA, individuals who receive qualified tips can deduct up to $25,000 per year from their taxable income. This deduction is available from 2025 through 2028, regardless of whether the taxpayer itemizes deductions on their personal return.
What’s Not Changing?
Tips received by employees will continue to be subject to federal employment taxes and income tax withholding. The IRS has announced there will be no changes to certain information returns or withholding tables for 2025. Form W-2, existing Forms 1099, Form 941 and other payroll return forms will remain unchanged for 2025. Also, 2025 federal income tax withholding tables won’t be updated for the qualified tip change.
What Counts as a Qualified Tip?
To be eligible:
- The tip must be cash-based and voluntarily given by customers or received through tip sharing.
- The occupation must be one that customarily and regularly received tips as of December 31, 2024. The IRS will publish a list of such occupations by October 2, 2025.
- Mandatory service charges (like automatic gratuities) don’t qualify.
Income Limits and Filing Rules
The deduction phases out at higher income levels:
- Single filers: Phaseout begins at $150,000 and ends at $400,000 modified adjusted gross income (MAGI).
- Married filing jointly: Phaseout begins at $300,000 and ends at $550,000 MAGI.
To claim the deduction:
- Married couples must file jointly.
- Self-employed individuals can only claim the deduction if their business income exceeds expenses.
Reporting Requirements
- Employees: Tips must be reported to the employer and shown on Form W-2 or reported by the employee on Form 4137.
- Self-employed individuals: Tips should be reported on Form 1099-NEC or 1099-K.
- Form W-2 and Form 1099-NEC or 1099-K will need to include the worker’s occupation so that the IRS may determine whether they’re eligible for the tip deduction.
IRS Guidance and Transition Relief
The IRS will offer transition relief for 2025, allowing employers and payors to use reasonable methods to estimate and report cash tips. Employers are encouraged to begin tracking tips now to ensure accurate reporting on 2025 W-2s.
This new deduction could provide meaningful tax savings for many in the service industry. As more guidance becomes available, staying informed and maintaining accurate records will be key to maximizing this benefit.
At Creative Planning Business Services, our experienced professionals partner with clients to help them understand reporting requirements and ensure their payroll systems are prepared. To learn more, schedule a call with a member of our team.
