What the new “No Tax on Tips” rules mean — explained by a tax attorney

As Ben Franklin once said and is oft quoted, "In this world, nothing can be said to be certain, except death and taxes." Recently however, the certainty is only that they'll be paid. The question remains, how much? Here, we'll explore the new "No tax on tips rules, and what they mean for you. If you work for tips or run a business that employs tipped workers, the new federal rules that took effect for tax year 2025 are huge news if bit little complicated. Below I explain clearly who benefits, what counts as a “qualified tip,” key limits and phase-outs, how employers are affected, and practical next steps.

Quick summary

• For tax years 2025–2028, eligible tipped workers can claim an above-the-line deduction for “qualified tips” — up to $25,000 per return. This means that the deductions are subtracted from your total income before you calculate AGI.
• The deduction is subject to a phase-out that begins when modified adjusted gross income (MAGI) exceeds $150,000 for single filers ($300,000 for joint filers).
• Payroll taxes (Social Security/Medicare) are still owed on tips and employers will continue to withhold employment taxes.
• The Treasury and IRS have published proposed guidance listing the occupations that qualify and defining “qualified tips.” Final regulations on the topic won't be released until after the public comment period. See that proposed guidance here.

What changed

Congress enacted the “No Tax on Tips” provision as part of the One, Big, Beautiful Bill. The statute allows eligible employees and self-employed individuals to deduct an amount equal to their qualified tips (reported on W-2, 1099, or Form 4137), subject to a $25,000 cap per return and other limits.

Important: this deduction reduces federal taxable income (it’s an above-the-line deduction), so it can help taxpayers who don’t itemize.

Who might qualify

Eligibility turns on occupation, form of tip, and reporting:

• Occupation: The IRS/Treasury will publish (and has proposed) a list of occupations that “customarily and regularly received tips” the proposed rule was put forth on September 22, 2025. Only tips earned in those qualifying occupations count as “qualified tips.” Examples announced in proposed guidance include bartenders, servers, many hospitality and entertainment occupations, and other service roles.
• Form of tip: “Qualified tips” generally mean voluntary tips paid by customers including cash, checks, debit/credit card tips, gift cards, and similar customer gratuities reported to the worker or employer. Some categories (e.g., tips tied to illegal activity) are excluded; the IRS proposed rules clarify acceptable forms.
• Reporting: Tips must be reported (to the employer and on wage/tax statements, or on Form 4137 if required). Only reported tips are eligible for the deduction.

Limits, phase-outs, and timing

• $25,000 cap: The maximum deduction is $25,000 per return.
• Income phase-out: The benefit phases out. The allowed deduction is reduced by $100 for each $1,000 of MAGI above $150,000 for single filers (and $300,000 for joint filers). Unfortunately for higher earners, this means that they'll see reduced benefit from this change
• Temporary window: The change is temporary (2025–2028). Don't count on it sticking around, while it may be extended in its current form or a modified form, it may also be allowed to expire.

What doesn’t change (and common misunderstandings)

• Payroll  taxes still apply. Tip income remains subject to Social Security and Medicare withholding; employers must continue to withhold and deposit employment taxes on tips. This deduction affects income tax only.
• State taxes may differ. States are not required to follow the federal deduction; many states may continue taxing tips as before. Check your specific state for guidance.
• It’s not an automatic pay raise. Because withholding rules and payroll systems may take time to adjust, workers may not see immediate changes to paychecks in 2025; the benefit typically appears when filing 2025 tax returns (filed in 2026).

Employer implications (what businesses should do)

• Identify qualifying roles. Employers should review the IRS/Treasury list of qualifying occupations and determine which employees qualify. Proposed regulations list many job types and invite comment, so if you have something to say this is your chance.
• Reporting & payroll updates. Employers must continue to report tips on W-2s and to withhold payroll taxes. Payroll platforms and accounting teams may need to update systems to separately track "qualified tips" for employee filings or employer payroll-tax credits created by the law.
• Communicate clearly to staff. Employees should be informed that the deduction is claimed on their tax return and that withholding may not immediately change their take-home pay. Employers should also coordinate with tax advisors to minimize errors.

Practical steps for employees and small businesses

1. Keep thorough records. Track tips by date, form (cash vs. card), and reporting (reported to employer or on a 1099/W-2/Form 4137). Good documentation matters.
2. Don’t assume automatic benefit. You must claim the deduction on your federal return; make sure tips are properly reported.
3. Check the IRS occupation list. Confirm your job is listed among occupations that “customarily and regularly” receive tips per IRS/Treasury guidance.
4. Talk to a tax professional. The phase-out and interaction with other deductions/credits can affect whether the change helps you. Contact a professional for advice specific to your situation.
5. For employers: Review payroll processes, W-2 reporting, and whether your business can claim any employer payroll-tax credits or reporting changes created by the law.

Why this matters (policy and practical notes)

Policymakers designed the deduction to give sizable tax relief to certain service workers. Estimates suggest the provision will help millions of workers but also has sizable budget effects and may shift incentives in the labor market. Because the rules are temporary and specific, planning now can help employees and employers maximize lawful benefits while staying compliant.

Need help applying this to your situation?

If you’re an employee wondering whether your tips qualify, or an employer updating payroll and reporting, our firm can help:

• Evaluate whether your occupation and tip income qualify under IRS guidance.
• Prepare accurate documentation and tax filings to claim the deduction.
• Advise employers about payroll changes, reporting, and tax credits.

Schedule a confidential consultation and we’ll walk through the options and numbers specific to your case.

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