Starting with tax year 2025 and running through 2028, tipped workers in qualifying occupations can deduct up to $25,000 of tips from their federal taxable income. This is the “no tax on tips” provision enacted in the One Big Beautiful Bill Act (P.L. 119-21). Like the overtime deduction, it reduces federal income tax but does not eliminate FICA taxes — Social Security and Medicare still apply to every dollar of tip income.
What the Law Says
26 U.S.C. §224, added by P.L. 119-21 (signed July 4, 2025), creates a deduction for “qualified tips” — tips received in an occupation that customarily and regularly received tips on or before December 31, 2024. The IRS published an eligible occupations list and Schedule 1-A Part V for taxpayers to claim the deduction (IRS IR-2026-28).
The Deduction at a Glance
| Single | Married filing jointly | |
|---|---|---|
| Maximum deduction | $25,000 | $25,000 |
| Phase-out starts at MAGI | $150,000 | $300,000 |
| Reduction per $1,000 over threshold | $100 | $100 |
| Fully phased out at MAGI | $400,000 | $550,000 |
Note: the maximum is $25,000 per individual, not per household. A married couple where both spouses earn qualifying tips can each deduct up to $25,000 (combined up to $50,000), provided MAGI is below the phase-out threshold (26 U.S.C. §224).
Worked Example: Restaurant Server
A single server earns $25,000 in base wages plus $20,000 in tips annually. Total AGI: $45,000. Tips are already included in that AGI because all tips are taxable income.
Without the tips deduction:
- AGI: $45,000
- Standard deduction: −$16,100
- Taxable income: $28,900
- Federal income tax: 10% × $12,400 + 12% × $16,500 = $1,240 + $1,980 = $3,220
With the tips deduction (all $20,000 qualifies; well below the $25,000 cap and well below the $150,000 phase-out):
- AGI: $45,000
- Standard deduction: −$16,100
- Tips deduction: −$20,000
- Taxable income: $8,900
- Federal income tax: 10% × $8,900 = $890
- Federal income tax savings: $2,330
FICA on the full $45,000 wages + tips still applies: 6.2% SS + 1.45% Medicare = 7.65% × $45,000 = $3,443. The tips deduction does not reduce FICA.
Important Limitations
Occupation must qualify. The IRS maintains a list of eligible occupations. Roles that received tips before 2025 — restaurant servers, bartenders, hotel staff, hair stylists, taxi and rideshare drivers — are expected to qualify. Service charges distributed by employers generally do not count as tips.
FICA still applies. You continue to owe Social Security and Medicare on all wages and tips. Employees must still report all cash tips of $20 or more per month to their employer (IRS Publication 531).
Married filing separately not eligible. MFS filers cannot claim this deduction.
No double benefit for the same dollars. Tips deducted under §224 cannot also be excluded from income under any other provision.
How This Deduction Is Claimed
Like the overtime deduction, the tips deduction is a Schedule 1-A Part V item on your annual tax return — not an automatic paycheck adjustment. Withholding from tips continues at normal rates throughout the year; the tax saving arrives when you file.
Keep thorough records of tip income and its source. A tip journal, daily records on your pay stubs, and the amounts reported on Form 4137 (for unreported tips) or included in your W-2 Box 1 form the basis of the deduction. A tax professional can help confirm which tips qualify under the IRS’s occupation criteria.
Use the federal income tax calculator to estimate how the deduction affects your annual tax bill.
Tips vs. Overtime Deduction: Key Differences
| Feature | Tips deduction (§224) | Overtime deduction (§225) |
|---|---|---|
| Maximum | $25,000 per person | $12,500 (single) / $25,000 (MFJ) |
| Occupation required? | Yes — customary tipped occupations | No — any FLSA-covered worker |
| Which pay element qualifies | Customer tips (not service charges) | The 0.5× FLSA premium only |
| FICA savings | None | None |
| Phase-out threshold | $150,000 / $300,000 MAGI | $150,000 / $300,000 MAGI |
Both deductions appear on Schedule 1-A Part V and both apply for tax years 2025–2028.
Reporting Requirements for Tip Income
Tip income is taxable income regardless of the deduction. Employees must:
- Report all cash tips of $20 or more per month to their employer by the 10th of the following month (IRS Publication 531).
- Tips withheld through payroll appear in W-2 Box 1 (federal wages) and Box 7 (social security tips).
- Unreported tips are reported on Form 4137; employees pay the employee share of FICA on those tips directly.
Failing to report tips is a separate compliance issue from the new deduction. Accurate records are essential for claiming the deduction and for avoiding FICA shortfalls at filing.
The paycheck calculator models tip income as part of your overall wages for withholding purposes.