New IRS Tip Deduction 2025–2028: What Workers and Businesses Need to Know

Introduction

The One Big Beautiful Bill Act (OBBBA), signed into law in July 2025, brings sweeping tax reforms for American workers. Among the most notable is the new deduction for qualified tips, designed to support service‑industry employees and self‑employed professionals. This provision applies from tax years 2025 through 2028 and offers significant opportunities for tax savings.

Key Features of the Tip Deduction

• Qualified tips: Voluntary cash or charged tips received directly from customers or through tip‑sharing arrangements.
• Maximum deduction: Up to $25,000 annually. For self‑employed individuals, the deduction cannot exceed net income from the trade or business where tips were earned.
• Income phase‑out: Deduction begins to phase out for taxpayers with modified adjusted gross income above $150,000 (single) or $300,000 (joint filers).
• Eligibility rules: Available to both itemizing and non‑itemizing taxpayers. However, self‑employed individuals in a Specified Service Trade or Business (SSTB) under Section 199A are not eligible. Employees working for SSTB employers are also excluded.
• Filing requirements: Taxpayers must include their Social Security number on the return and file jointly if married to claim the deduction.
• Employer reporting: Employers and payors must furnish statements to taxpayers and file information returns with the IRS or SSA, showing cash tips received and the occupation of the tip recipient.
• IRS guidance: By October 2, 2025, the IRS will publish a list of occupations that “customarily and regularly” received tips as of December 31, 2024.
• Transition relief: For tax year 2025, the IRS will provide relief for taxpayers claiming the deduction and for employers adapting to new reporting requirements.

Impact on Workers and Employers

✅ Service‑industry employees: Waiters, bartenders, hotel staff, and other tipped workers stand to benefit most, potentially reducing taxable income by thousands of dollars.

✅ Self‑employed professionals: Freelancers in eligible occupations can deduct tips, but only up to their net business income.

✅ Employers: Must comply with new reporting rules, though the IRS has granted transition relief for 2025 to ease the burden.

Examples:

• Example 1 – Under the limit:
  - Anna works as a server and earns $20,000/year in tips.
  - These tips are reported on her W-2 → 👉 She will not pay federal income tax on the $20,000.
  - But Social Security & Medicare (~7.65%) will still be withheld.

   

• Example 2 – Over the limit:
  - Tom works at a nail salon and earns $30,000/year in tips.
  👉 He won’t pay federal income tax on the first $25,000, but:
  - The remaining $5,000 will still be taxed federally.
  - The entire $30,000 is still subject to Social Security and Medicare.

Who does NOT qualify?

• Businesses that keep tips without sharing them with employees
• Workers who do not report tips properly
• Owners who withhold tips left through POS and don’t pass them to employees
• Mandatory service charges (not considered legal tips)

Conclusion

The Tip Deduction under OBBBA represents a major tax break for service‑industry workers and eligible self‑employed individuals. With a maximum deduction of $25,000 per year, this provision can significantly reduce taxable income. Employers and workers should prepare for new reporting requirements, while taxpayers should monitor IRS guidance for the official list of qualifying occupations.

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