For some professions, tipping is more than just a few extra dollars to show your appreciation. It’s a critical source of compensation for the worker and could mean the difference between having enough or barely getting by.
According to a study by Yale, approximately 4 million American workers rely on tips for income (about 2.5% of the total workforce). This includes not just restaurant workers but also those across many other service industries, such as cosmetologists, rideshare drivers, casino workers, etc.
Just like any other form of compensation, tips are considered to be taxable income. However, these workers are about to get a major break.
As of July 4, 2025, President Trump signed the One Big, Beautiful Bill (OBBB). Among many other changes, this piece of legislation makes it so that a large portion of tipped income will no longer be taxable – a promise Trump proposed several times throughout his presidential campaign tour.
So what does this mean if tips are normally part of your annual compensation? In this post we’ll dive into the specifics and how it may affect your bottom line.
What Does “No Tax on Tips” Mean?
The OBBB allows eligible Americans earning “qualified tips” to take a deduction on their federal tax return – up to a maximum of $25,000 per individual.
To put this deduction into context, if you’re in the 22% tax bracket and claim the full amount, then you’d save approximately $5,500 in taxes.
Here are a few more details about this deduction to keep in mind:
- If you made over this amount in tips, then the portion that exceeds the annual limit will be considered taxable like normal. For example, if you earned $30,000 in tips, then you’d pay income taxes on the $5,000 over the $25,000 deduction.
- If you earned less than $25,000 in tips, then the deduction is limited to actual amount earned. For example, if you made $20,000 in tips, then your deduction would be $20,000 – not $25,000.
- If both you and your spouse work in industries that include earning qualified tips, then you both may be able to claim a deduction (up to $25,000 each).
Will My Paycheck Be Bigger?
Unfortunately, not right away. Because this tax break is a deduction, it won’t be realized until you file your federal taxes (prior to April 15th of the following year).
For now, tips will be reported as they always have – either to your employer or through quarterly estimated (ES) tax payments if you’re self-employed. Recall that by law, you have to report all your tips to your employer if they total $20 or more in a single month.
However, once you eventually file your annual income taxes and take the deduction, it may lower your taxable income. This could result in either a lower tax bill or receiving a higher refund check.
Who Qualifies for the Tip Tax Deduction?
Those workers who want to claim the $25,000 deduction will have to meet certain criteria to be eligible.
Valid Social Security Number
You must have a Social Security number and be authorized to work in the U.S.
Qualified Tips
The IRS considers “qualified tips” to be voluntary cash, those added to credit card charges, or through pooled tip sharing.
The Treasury Department further defines that this income must come from occupations that “customarily and regularly” receive tips such as:
- Bartenders, wait staff, and many roles related to food and beverage prep
- Gambling-related roles (e.g., dealers)
- Entertainment (e.g., DJs, ushers)
- Hospitality/guest services (e.g., bellhops, concierges)
- Rideshare drivers
- Cosmetologists such as hair stylists and nail technicians.
- Etc.
Interestingly, this definition also includes non-traditional tip earners such as influencers and digital content creators. For instance, if your favorite YouTube channel has a Patreon account, then the gratuities they receive may be considered as tips and count towards the deduction.
It’s important for the IRS to put these occupational definitions in place to prevent abuse by bad actors. For instance, a contractor cannot do work on your home and claim that your payment was a tip to avoid owing taxes.
Income Requirements
Like other Federal tax deductions, this incentive is not available to high-income earners. The IRS considers this to be anyone with a MAGI (modified adjusted gross income) above $150,000 (or $300,000 for joint filers).
For reference, MAGI is calculated by taking your Adjusted Gross Income (AGI) and adding back certain deductions and untaxed income sources. It’s a commonly used metric by the IRS to determine eligibility for various tax credits, deductions, and other financial benefits such as whether or not you can contribute to a Roth IRA.
Filing Status
Those who file as individuals or “married filing jointly” may qualify. Individuals claiming “married filing separately” cannot claim the benefit.
Do I Still Need to Track My Tips?
Yes. This new tax break does not change the fact that tips must be tracked and reported as they always have. This is for a few reasons.
The first is that there is no break for payroll taxes such as FICA (Social Security and Medicare). Even though you won’t have to pay income taxes on your tips, FICA taxes will still be calculated based on your gross earnings (before any taxes have been subtracted). Therefore, the IRS needs to know how much money in total (tips and wages) you’ve earned throughout the year.
The same logic may apply to your state taxes. Depending on where you live and how taxes at the state level are calculated, this gross earnings figure may play a role.
Lastly, remember that the $25,000 is a deduction. If you earn more than this figure, then you’ll pay taxes on the amount it exceeds. If you earn less, then you’ll only be able to claim the lower amount. In both cases, accurate reporting of your total tips earned is required.
How Long Will This Law Be in Effect?
Currently the OBBB only provides for the tip tax deduction to in effect through 2028. After that, unless the new administration at that time extends it, the law would expire. That would mean reversing back to all tips being fully taxable.
Put Your Savings to Use
If you anticipate that you’ll be able to take advantage of this new tax rule for tips, then why not make the most of it? Review your budget and your savings objectives.
Plan on putting those tax savings to work by paying off a debt, contributing to your Roth IRA, or building up your emergency fund.
Though it may not seem like much now, a little bit can go a long way. What’s important is to assign those tax savings a job now so that they will be better utilized in a way that aligns to your financial goals.
Featured image credit: Unsplash
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