Are tips being taxed in 2025? In September 2025, the government released a list of jobs that usually receive tips. People in these jobs can deduct their tips from their taxes between 2025 and 2028. After 2028, this tip deduction will no longer be available.
Thanks to a recent update to the One Big, Beautiful Bill Act (OBBBA), workers can now deduct tips from their taxable income. This “no taxes on tips” law comes with a host of changes for both employees and employers.
To help you join the 84% of small business owners who feel fairly confident when filing business taxes, we’ve put together this guide on everything you need to know about the 2025 “no tax on tips” deduction.
In July 2025, a new provision for the One Big, Beautiful Bill Act (OBBBA) introduced a deduction for tax on tips. This above-the-line deduction allows employees and self-employed individuals to deduct from their income qualified tips up to a max of $25,000 a year.
This deduction, which applies only to federal income tax, will be effective from 2025 through 2028, unless extended later.
This new provision reduces the amount of tax you owe. It’s different from a tax credit, which provides a dollar-for-dollar savings off your tax bill.
The new “no tax on tips” deduction will be available for those who work in occupations that “customarily and regularly” receive tips. As the bill was recently signed into law, some eligibility requirements are not yet available, but here is what we know.
To qualify for the income tax deduction under OBBBA, an individual's tips must satisfy specific requirements. The occupation must be one of the nearly 70 identified by the IRS as customarily receiving tips, like waitstaff, and the tips themselves must meet the definition of "qualified tips".
Outside of the occupational guidelines, this deduction will apply only to qualified tips reported on a W-2, 1099, or Form 4137. This means the deduction will be available to both traditional employees and self-employed individuals.
A work-eligible Social Security number will be required to file for this deduction. Additionally, those who are married will need to file jointly. This deduction will not be available when married filing separately.
Unfortunately, individuals who work for (or are self-employed under) a business that is categorized as a Specified Service Trade or Business (SSTB) won’t be able to take this deduction and will have to pay taxes on tips.
The new tip tax deduction does come with some income limitations and phase-out rules. To qualify for the full deduction, the MAGI (modified adjusted gross income) caps are:
Above these income amounts, the deduction will begin phasing out and will zero out at:
This deduction will be available to both those who take the standard deduction and those who itemize their deductions.
The maximum annual deduction (per individual) is $25,000. However, for self-employed taxes, there is an added rule: The deduction cannot exceed net income from tip-based work.
So, if you made $40,000 with half that being tips, but you had $25,000 worth of expenses, you’d only be able to deduct $15,000 of your tips instead of the full $20,000.
Throughout the year, employees must report their tip earnings to their employer at least once a month. Employers then need to submit this income information to the IRS.
Come tax filing time, employees will then be able to deduct up to $25,000 of their tip income on their taxes.
Key tax updates:
Let’s take a look at an example scenario on how to calculate taxes on tips with the new rules:
Sarah is a hair stylist who earns $40,000 per year, including $8,000 in tips. Below is what her tax bill would have looked like before the deduction, and now with the new no taxes on tips deduction.
The new deduction only impacts the federal income tax, so tips will still be subject to full Medicare, Social Security, and state/local level taxes. These taxes will still be withheld from your tips. If you exceed the $25,000 threshold in tips, then federal income taxes will also be withheld. Federal income tax will not be withheld on tips under $25,000.
However, it is worth noting that for 2025, federal income taxes will still be withheld from tips as the new law was signed with a retroactive date. This gives employers time to update their payroll software and withholding settings.
Another added benefit of the deduction is that it reduces taxable income, which could result in a lower tax bracket and even more tax savings.
Medicare and Social Security taxes are often referred to as FICA taxes. Only unearned income, like investment income or retirement income, is exempt from FICA taxes.
To take full advantage of the deduction, tipped employees must maintain meticulous records. Starting a daily log may be helpful.
Per IRS requirements, any tips a person earns, whether via cash, check, or credit card, must be reported to their employer no later than the 10th of the following month. This will ensure tip income is recorded accurately on W-2s or 1099s.
Employees who are unable to report tips earned to their employer can use Form 4137 to calculate Social Security and Medicare taxes owed on their tips. This form should be attached and sent in with their tax return.
The start date for this deduction is January 1st, 2025, which means 2026 will be the first tax filing year in which you can claim it on your taxes.
While the tax law change is retroactive to the beginning of 2025, the IRS has promised to provide “transition relief” to employers as they work to comply with the new guidelines.
Employers will have to pay their proportion of FICA taxes on the tips that employees report.
To ensure that employees can claim the full tip deduction amount, employers will need to accurately report tips earned on all employee W-2s and on contractors' 1099s. This will require the separate tracking of wages paid and tips. If your current system can’t support this, you may need to adjust or upgrade your accounting solution.
With the new deduction, it may also be helpful to allow employees to adjust their W-4 withholding so that they aren’t overpaying their taxes.
Aside from business taxes, the change in tax law may impact other areas of your business, like hiring, retention, employee classification, and customer satisfaction.
For instance, according to the IRS, charges such as automatic gratuities and service charges are not considered tips. Not only can this make accurately tracking tips harder, but not getting the deduction for this can frustrate employees, and may lead to a need to revise your policies.
For self-employed individuals, recording and reporting tips work a little differently. If a business reports your compensation via a 1099 form, they may not account for tips, so you’ll need to document them yourself.
To make sure FICA taxes are calculated accurately, you’ll also need to include any tips you receive when estimating your quarterly payments.
When it comes to filing your taxes, the guidelines are still a bit murky. Currently, as a self-employed individual, there is no way to report your tips separately from the rest of your income. This means there will likely be a form change ahead of filing taxes in 2026.
There is one limitation specific to the self-employed: The deduction cannot exceed your net profit from your tipped job.
Let’s look at an example scenario. Lisa’s main job is as a bartender, but she also has a side hustle delivering food. Both jobs are tipped, but as a bartender, she is paid via W-2, while the food delivery is 1099 income.
Here’s what she earns for 2025:
Lisa racks up $4,000 in mileage and other expenses for her food delivery job. This means her net profit for that job is $4,000, which is $500 less than her tipped income for the job. So she’ll only qualify for a deduction of $9,000, instead of the full $9,500 she made in tips.
According to the US Bureau of Labor Statistics, roughly 17 million people in the US are self-employed. This number is likely to grow, as our recent Entrepreneurship in 2025 survey showed 54% of respondents were aiming to start a new business in 2025.
The new no tax on tips deduction certainly comes with many tax-time benefits, but this doesn’t mean all taxes will magically disappear.
Employers will still need to withhold FICA taxes on tip income. When employees reach the $25,000 tip threshold, their tips will again be subject to federal income taxes.
Additionally, the OBBBA doesn’t impact state and local taxes. For those who live and work in states, cities, counties, and townships that levy taxes on all income, tips will still be fully taxed.
The provision was included in the OBBBA as a temporary measure for the 2025–2028 tax years. It could be extended or made permanent, but that will require further action from Congress. If it is not extended, it will expire after the 2028 tax year.
For small business owners and sole proprietors, implementing this new tax provision may be difficult. Accurately tracking tips requires up-to-date tax software.
QuickBooks provides accounting, payroll, and tax tools to help you seamlessly implement the new law regarding no taxes on tips. Plus, our platform can help you manage future withholding adjustments and all current and future tax benefits, deductions, and credits. Learn more about our accounting software today.
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