The One Big Beautiful Bill Act (OBBBA) exempts tip income from taxation. But as with any new tax law, the fine print matters, and some of these details still need clarification. From January 1, 2025, through December 31, 2028, you can deduct up to $25,000 as a deduction equal to the amount of qualified tips you receive during the year. These tips must be included on IRS-approved statements furnished to the individual to take advantage of the tax-free deduction.

There is an income limit of $150,000 for single filers and $300,000 for joint filers. This income limit is based on modified adjusted gross income, including tips. The deduction amount is reduced (but not lower than zero) by $100 for each $1,000 in excess of these amounts. For example, Joanie Tipster, a single filer with a modified adjusted gross income of $155,000, exceeds the limit by $5,000. Therefore, her tip deduction will be reduced by $500, which equals ($5,000/$1,000) x $100.

Qualified tax-free tips

To qualify as a tax-free tip:

• You must get the tip in the ordinary course of business
• It must be voluntary
• It is not subject to negotiation
• The payer determines it

A list of qualifying businesses will be published on or before December 31, 2025. However, the tax bill specifically mentions the following:

• Food and beverage for consumption, if tips are customary
• Barbering and hair care
• Nail care
• Esthetics (services like body and spa treatments)

Of special note, if you work in a specified service trade or business (SSTB), you may not take the tip deduction. An SSTB is a type of business that provides services in various fields, including health, law, accounting, consulting, and financial services.

What action to take

If you qualify for this deduction, here are some tax tips to consider:

• Get your reporting in order. Remember, it’s already mid-year. You’ll need to prove your tips to get this deduction. Start getting your tip records in order, and then you can reconcile your tip income with your employer’s reporting of your tips.
• The large-party tip. Many restaurants automatically add a tip when the party size is larger. On the surface, the bill seems to exclude these tips from the deduction because the tip is no longer voluntary. Until there is clarification, it may make sense to ask your employer to consider an alternative practice or determine how to confirm the voluntary nature of such a tip.
• Your tips are not covered! There are a large number of jobs that regularly receive tips that are not on the bill. Bellhops, cabbies, Uber drivers, and delivery jobs, to name a few. Do not lose heart, as the IRS is tasked with figuring out which jobs should be included, but won’t have to do so until on or before the end of the year. Hopefully, it will be complete within 90 days.
• Cash not reported. If you receive cash but it’s not reported, it can’t be used as a deduction. So, do the math for your situation and consider properly recording this as tip income.
• Patience is required. There will be clarification of these rules from the IRS within the next 90 days. So even if your tip income is not expressly included as of now, still keep track of it, as it could easily make the IRS’s list.

The fine print matters

To receive the deduction:

• You must report it. This means that this tip income will ultimately be reported on a W-2. This means you must have a valid Social Security number.
• They must be cash. The IRS defines cash to include cash, credit cards, debit cards, and digital payment tools. This then implies that any non-cash tips and receipt of cryptocurrencies would not qualify.
• It will still be taxed (somewhat). While you will receive a tip deduction on your tax return, that tip income will still be subject to Social Security and Medicare taxes.
• You must have income. The deduction will reduce your taxable income. But if your taxable income is already at or below zero (because of other tax breaks like the standard deduction), there is minimal to no benefit for this new deduction.
• If married, file jointly. The benefit does not exist for married couples filing separately.
• Tip behavior cannot be created. If your employer did not customarily make tips before this law, they cannot suddenly start tipping to take advantage of the benefit.

Congress is aware that there will be a temptation to reclassify taxable income as tip income to take advantage of this law change, so it’s tasking the IRS with developing guidelines to prevent this from happening. Stay tuned. There is more to come on tax-free tips. Contact our RRBB advisors if you have any questions.