Understanding the ‘No Tax on Tips’ Rule and Proposed IRS Guidance: A Resource for Employees

Reconciliation Bill H.R.1 introduced a new “no tax on tips” provision allowing workers in tipped occupations to claim a tax deduction for qualified tips received. This deduction will be available for tax years 2025 through 2028. With the ability to deduct qualified tips from taxable income, an individual or couple’s tax liability may be reduced, regardless of whether they claim the standard deduction or itemize.

Both eligible employees and self-employed individuals can take the deduction against their tips by fulfilling several criteria with respect to their income, type of tips, and their occupation.

Taxpayers may deduct up to $25,000 in qualified tip income per tax return. In other words, the tip income deduction is available to both single and joint filers but is applicable per tax return, not per individual. A married couple filing a joint return can claim a maximum deduction of $25,000 in qualified tip income even if their combined qualified tips exceed that amount where both spouses work in occupations that customarily and regularly receive tips. Once a taxpayer’s modified adjusted gross income reaches the threshold of $150,000 ($300,000 for joint filers), the phase out begins. For each $1,000 that a worker makes over $150,000, the amount of their deduction is reduced by $100.

To qualify for the deduction, tips must meet the criteria of qualified form, voluntary payments, and proper reporting. Additionally, taxpayers cannot claim this deduction if they file as Married Filing Separate, since current tax law specifically excludes this filing status from eligibility for the tip deduction.

Qualified Form

A tip is only deductible if received by the customer in cash or an equivalent substitute. Acceptable methods of payment include checks, debit cards, credit cards, gift cards, and tangible/intangible tokens that are available to be exchanged for a fixed amount of cash. Methods of payment that lack a clear cash exchange value such as event tickets, meals, services, and most digital assets do not count as qualified tips and therefore cannot be deducted.

Tips received by employees under a tip-sharing arrangement are eligible for the deduction. The proposed regulations clarify that tips reported pursuant to an agreement under the Tip Rate Determination Agreement (TRDA) or Gaming Industry Tip Compliance Agreement (GITCA) program are eligible for the deduction, provided that the participating employee in the TRDA or GITCA program is otherwise eligible and reports tips using the tip rates established under their agreement. Additionally, the proposed regulations clarify that an employee participating in the TRDA or GITCA program may report additional qualified tips to the IRS on Form 4137.

To discourage employers from taking advantage of the tax deduction and reclassifying their income, tips will not be eligible for the deduction if the recipient of the tip is an owner or employee of the payor of the tip.

Voluntary Payments

Tips must be completely voluntary to qualify. Some businesses include service charges based upon a percentage of a customer’s bill (e.g., a restaurant adding an 18% service charge for a large party). The proposed regulations clarify that such fees, and any similar arrangements, are not qualified tips unless the customer is expressly provided with the option to disregard or modify the charge without consequence.

When a tip is prompted, for example, on a point-of-sale device or a receipt, the customer must have the option to opt out, or it will not qualify. For example, if a minimum percentage tip is required, the lowest tip percentage required would not qualify but anything the customer chooses to pay beyond that amount would constitute a qualified tip.

Specified Service Trades or Businesses

Qualified tips do not include tips received in the course of a trade or business that is a specified service trade or business (SSTB). Employees of such businesses are also not eligible to deduct tips received from work performed for such businesses. SSTBs include businesses that perform services in certain fields such as health, law, accounting, actuarial science, consulting, performing arts, athletics, financial services, and brokerage services. SSTBs also include businesses that rely on an individual’s skill and reputation (think celebrities and other public figures) and those involved in certain investment management and securities activities.

Let us unpack what the SSTB restriction means for a W-2 employee. SSTB workers (e.g. W-2 employees) working for SSTB businesses are not eligible for tip deduction. For example, singer (SSTB worker) performing in a theatre (SSTB) would be ineligible for the deduction. In contrast, non-SSTB workers are eligible for the deduction. For instance, a theater (SSTB) contracts with a non-SSTB company to provide bartending services during an event. The bartender, as an employee of a non-SSTB company, receives qualified tips and can claim the deduction if otherwise eligible. Another example would be a pianist or a singer who is hired by a hotel to perform in the hotel’s lobby and receives cash tips. Despite engaging in performative arts (an SSTB), the tips qualify since the employer (i.e., the hotel) is not an SSTB.

Reporting Requirements for Employees and Self-Employed Individuals

W-2 Employees

Only qualified reported tips are eligible for the deduction. Employees must keep a daily log of all cash and charge tips (using Form 4070A or a similar log), including tips from credit/debit cards, shared tips, and tips paid to others.

Cash tips of $20 or more in a month must be reported to the employer by the 10th of the following month, using Form 4070, an employer-provided form, or an approved electronic system. Noncash tips are not reported to the employer but must be included as income on the annual tax return.

The $25,000 tip deduction reduces only federal income tax, not Social Security, Medicare, or self-employment taxes. State tax treatment depends on state conformity with the federal code. For qualifying occupations, employers won’t withhold federal income tax on reported tips or include them in Box 1 of the 2026 W-2; Social Security and Medicare taxes will still be reported in Boxes 5 and 7, with new codes to report qualified tip income and occupation. For 2025, employees must track their own qualifying tips and confirm occupation eligibility, as the 2025 W-2 won’t separately identify these items.

Self-Employed Individuals (1099 Contractors)

Self-employed individuals must verify occupational eligibility and keep a detailed log of all tips, including cash and noncash tips, tips from credit/debit cards, and tips shared or received through arrangements. The log should include the date, amount, and source of each tip.

All tips, along with other self-employment income, should be reported as gross receipts on Schedule C of Form 1040. The $25,000 deduction does not apply to self-employment taxes, and both the employer and employee portions of Social Security and Medicare taxes must still be calculated and paid. Importantly, the deduction cannot exceed the net income from the trade or business—it cannot create a loss.

List of Occupations That Receive Tips

Using guidelines from various source (such as the U.S. Department of Labor Fair Labor Standards Act), the Department of Treasury and IRS have proposed a list of occupations that customarily and regularly received tips on or before December 31, 2024.

This chart provides the proposed list of occupations.

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