JJ THE CPA
OBBBA:
No Tax on Tips
Up to $25,000 Tax Deduction
By Joshua Jenson, CPA (JJ the CPA)
With the One Big Beautiful Bill Act (OBBBA), there is a new provision: "No Tax on Tips!" However, take note this is really is a new tax deduction. All tips must still be fully reported as income, and then, up to that tip income, no more than $25,000, a tax deduction is available. A crucial point to note is that only voluntarily paid tips are included, so automatic gratuity (tips) is excluded. There are several additional factors to consider. The first important aspect to grasp is that this is a "below the line" tax deduction, which means it is available regardless of whether the standard deduction or itemized deductions are taken.
CLICK HERE to check out the 3.5 Hr seminar plus 300+ page PowerPoint
Here is what is covered in detail in the tax seminar:
Up to $25,000 Deduction on Tip Income Reported
•Starting in 2025 through 2028, may be deducted annually
•All tip compensation for W-2 employees and 1099 workers is still reportable income
•Applies to cash and non-cash tips (e.g., Venmo, credit card, cash)
•Only qualified tip income is defined as voluntarily paid
-Automatic gratuity is EXCLUDED from tips that qualify
•To be tracked and reported separately on Forms W-2 and 1099.
•Separately stated “below-the-line” deduction
•A taxpayer can either take the standard deduction or itemize deductions
•Taxpayers must include their Social Security Number on the return
•This will only save federal income tax
–Does not exempt the tips from payroll or self-employment taxes
•Per tax return deduction. Not a per-person deduction
Additional items to note for self-employed individuals:
•For self-employed, the deduction may not exceed the individual’s net income (without regard to this deduction) from the trade or business in which the tips were earned
•Self-employed individuals in a Specified Service Trade or Business (SSTB) under section 199A are not eligible
Phases out for taxpayers with modified adjusted gross income (MAGI) over $150,000 and $300,000 for MFJ.
The OBBBA sets a hard cap on the tip deduction based on how you file — not how much you earn in tips. Who gets to deduct how much. MFS filers? They’re out. Everyone else? Capped at $25K per return.
• Single — $25,000 deduction
• Head of Household — $25,000 deduction
• Married Filing Jointly (MFJ) — $25,000 combined (not $25K per spouse)
• Qualifying Widow(er) — $25,000 deduction
• Married Filing Separately (MFS) — $0 deduction allowed
⚠️ No partial credit for MFS — it's all or nothing, and MFS gets nothing.
Starting with tax year 2026, employers and other payors must file information returns with the IRS (or SSA) and furnish statements to taxpayers showing certain cash tips received and the occupation of the tip recipient.
•To be reported on a Form W-2, Form 1099, or other specified statement furnished to the individual or reported directly by the individual on Form 4137
•Employees whose employer is in an SSTB also are not eligible (See slide on SSTB)
•Tips received in occupations that are listed by the IRS as customarily and regularly receiving tips on or before December 31, 2024
•The IRS will provide transition relief for tax year 2025 for taxpayers claiming the deduction and for employers and payors subject to the new reporting requirements.
AUTOMATIC GRATUITY EXCLUDED AS QUALIFYING TIPS FOR THE DEDUCTION
Typically, restaurants have policies that charge an automatic gratuity for large parties. It would lead to a conclusion that mandatory tips won’t be tax-deductible under the new law. The OBBBA states that the "no tax on tips" policy doesn't cover tip income unless it was "paid voluntarily without any consequence in the event of nonpayment, is not the subject of negotiation, and is determined by the payor.”
The IRS has made clear before the OBBBA (May 8, 2025) that fees are not considered tips. Per the IRS, “Charges added to a customer's check, such as for large parties, by your employer and distributed to you, should not be added to your daily tip record. These additional charges your employer adds to a customer's bill do not constitute tips as they are service charges.”
https://www.irs.gov/businesses/small-businesses-self-employed/tip-recordkeeping-and-reporting
Per the IRS (May 8, 2025):
“Tips are discretionary (optional or extra) payments determined by a customer that employees receive from customers.
Tips include:
• Cash tips received directly from customers.
• Tips from customers who leave a tip through electronic settlement or payment. This includes a credit card, debit card, gift card or any other electronic payment method.
• The value of any noncash tips, such as tickets or other items of value.
• Tip amounts received from other employees paid out through tip pools, tip splitting, or other formal/informal tip sharing arrangement.
• Tips also include tips received by both directly and indirectly tipped employees.”
https://www.irs.gov/businesses/small-businesses-self-employed/tip-recordkeeping-and-reporting
“An employer's or employee's characterization of a payment as a 'tip' is not determinative. Distributed service charges (often referred to as 'auto-gratuities' by service industries) should be characterized as non-tip wages.”
“Revenue Ruling 2012-18 reaffirms the factors that are used to determine whether payments constitute tips or service charges. Q&A 1 of Revenue Ruling 2012-18 provides that the absence of any of the following factors creates a doubt as to whether a payment is a tip and indicates that the payment may be a service charge:
• The payment must be made free from compulsion.
• The customer must have the unrestricted right to determine the amount.
• The payment should not be the subject of negotiation or dictated by employer policy; and,
• Generally, the customer has the right to determine who receives the payment.”
Revenue Ruling 2012-18
