Tips are wages. Federal income tax, Social Security (6.2%), and Medicare (1.45%) all apply to cash tips, credit card tips, and electronic tips — just as they do to regular wages (IRS Publication 531; IRS Tax Topic 761). For tax years 2025 through 2028, a new federal deduction under IRC §224 (the One Big Beautiful Bill Act, P.L. 119-21) allows workers in qualifying occupations to deduct up to $25,000 in tips from federal taxable income. The deduction phases out for MAGI above $150,000 (single) or $300,000 (joint) and does not reduce FICA.
Use the paycheck calculator to see how tipped income is estimated in your paycheck.
How Tip Reporting Works
Cash tips received directly from customers must be reported to your employer. The IRS requires reporting by the 10th day of the month following the month in which the tips were received (unless the total is under $20 for the month). Employers add reported tips to W-2 Box 1 (wages) and Boxes 5 and 7 (Social Security and Medicare wages).
Credit card and electronic tips are typically included in each payroll run automatically — the employer already knows the amount from POS records.
Allocated tips (Form W-2 Box 8): If the employer determines that employees in a large food or beverage establishment did not report enough tips, the IRS requires the employer to allocate additional tips on W-2s. These allocated amounts may also be taxable.
Worked Example: Server at $35,000 Annual Wages Including $18,000 Tips
Assume a single filer, all wages and tips reported, standard deduction only, MAGI below $150,000.
Without the tips deduction:
| Item | Amount |
|---|---|
| Gross wages (including tips) | $35,000 |
| Standard deduction | $16,100 |
| Federal taxable income | $18,900 |
| Federal income tax | $2,020 |
| Social Security (6.2%) | $2,170 |
| Medicare (1.45%) | $508 |
| Total taxes | $4,698 |
| Estimated take-home | $30,302 |
With the 2025–2028 tips deduction ($18,000):
| Item | Amount |
|---|---|
| Gross wages (including tips) | $35,000 |
| Standard deduction | $16,100 |
| Tips deduction | $18,000 |
| Federal taxable income | $900 |
| Federal income tax | $90 |
| Social Security (6.2%) | $2,170 |
| Medicare (1.45%) | $508 |
| Total taxes | $2,768 |
| Estimated take-home | $32,232 |
The tips deduction saves $1,930 in federal income tax. FICA ($2,678) is unchanged.
The 2025–2028 Tips Deduction (IRC §224)
Key rules from 26 U.S.C. §224 and the IRS newsroom (IRS IR-2026-28):
| Feature | Rule |
|---|---|
| Maximum deduction | $25,000 |
| Phase-out starts | MAGI over $150,000 (single); $300,000 (MFJ) |
| Phase-out rate | $100 reduction per $1,000 of MAGI above the start |
| MFS filers | Deduction not available |
| Qualifying tips | Occupations customarily tipped on or before Dec 31, 2024 |
| Excluded | Tips in specified service trades or businesses (§199A SSTBs) |
| FICA | Still applies to all tips |
| Tax years | 2025–2028 |
| Claimed on | Schedule 1-A Part V |
Phase-out example: A single filer with MAGI of $165,000 and $20,000 in tips:
- MAGI over $150,000: $15,000 → $15 reductions of $100 = $1,500 phase-out
- Deductible tips: min($20,000, $25,000) − $1,500 = $18,500
FICA on Tips: No Change from the New Law
FICA applies to all tips regardless of the tips deduction. Social Security (6.2%) and Medicare (1.45%) are calculated on total reported wages including tips, up to the Social Security wage base ($184,500 in 2026).
The employer also pays matching FICA on tips. For tipped employees, employers can claim the FICA Tip Credit (IRC §45B) to offset part of their employer FICA on reported tips above the federal minimum wage — but that is an employer credit, not a benefit to the employee.
Tips and Social Security Benefits
Reported tips count toward Social Security wages, which affects your eventual benefit. Unreported tips do not. A worker who consistently underreports cash tips reduces both their current taxable wages (saving some tax now) and their future Social Security earnings record. The long-term cost of lower benefits often exceeds the short-term tax savings.
Tips from Tip Pools
Tips shared through a tip pool are taxable to each recipient, not to the original receiver. If you receive cash from a tip pool, report it as tips. If you give tips to a pool, only the net amount you retain is reportable income.
For the broader discussion of the federal policy and which occupations qualify, see no tax on tips explained. For how FICA applies to your full paycheck, see FICA tax explained.