Big Beautiful Bill Boosts Take-Home Pay for Tipped Employees: Everything You Need to Know

By Tax&Facts | Published on Feb 4, 2025 | Read: 3 Mins

Tips are an important part of income for millions of service in dustry workers, from restaurant servers and bartenders to hairstylists and taxi drivers. While tips are a welcome boost to earnings, many workers are unaware that these tips are taxable income and must be reported to the IRS. Recent changes in tax law are also reshaping how tip income is treated, making it essential to understand your obligations and potential deductions.

What Counts as Tip Income?

The IRS defines a tip as any voluntary payment received directly from a customer or through tip-sharing arrangements for services performed. Common examples include:

Cash tips received directly from customers
Credit or debit card tips processed through the business
Tips shared among staff in a tipping pool

It is important to note that mandatory service charges or fees added by a business (like a “gratuity” for large parties at restaurants) are not considered tips but are treated as regular wages.

How Tips Are Taxed

Tips are considered taxable income, meaning they are subject to:

Federal income tax
State income tax (in most states)
Social Security and Medicare taxes (FICA)

Employees are generally required to report tips to their employer if they total $20 or more in a month. Employers then include these tips on Form W-2. Self-employed individuals must report tips on their income tax return using Form 1040 and, if applicable, Form 4137 for unreported tips.

Failing to report tip income can result in penalties and interest, so it’s critical to keep accurate records.

The “No Tax on Tips” Deduction (2025–2028)

Starting tax year 2025, a new provision allows employees and self-employed individuals to deduct up to $25,000 of “qualified tips” from their taxable income. Key points include:

Applies to occupations customarily and regularly receiving tips, as listed by the IRS by December 31, 2024
Tips must be properly reported on Form W-2, Form 1099, or Form 4137
Self-employed workers cannot deduct more than their net income from the trade or business in which tips were earned
The deduction phases out for higher earners: $100 reduction for every $1,000 of MAGI above $150,000 (single) or $300,000 (joint)
Available through 2028

This deduction offers significant tax relief for workers in tipping occupations, potentially saving thousands in federal income taxes each year.

Tips for Reporting and Recordkeeping

To comply with IRS rules and maximize your deductions:

1. Keep a daily log of tips received, including cash, card payments, and pooled tips
2. Report all tips to your employer if you are an employee
3. File Form 4137 for unreported tips if self-employed or for tips not included on W-2
4. Track total tip income for the “No Tax on Tips” deduction to claim it accurately on your return

Accurate recordkeeping not only ensures compliance but also helps workers take advantage of new tax-saving opportunities.

Bottom Line

Tips are more than just extra income—they are taxable income that must be reported. However, the recent introduction of the “No Tax on Tips” deduction gives tipped employees and self-employed workers a chance to reduce their taxable income and keep more of what they earn. Staying informed and organized is key to making the most of these rules.

FAQ Frequently Asked Questions (FAQ)

Q1: What counts as tip income?
A1: The IRS considers a tip any voluntary payment received for services, including:

Cash tips from customers
Credit or debit card tips processed through a business
Tips shared in a tip pool among staff

Important: Mandatory service charges or automatic fees (like a “gratuity” for large parties) are not tips; they are treated as regular wages.

Q2: How are tips taxed?
A2: Tips are taxable income and subject to:

Federal income tax
State income tax (in most states)
Social Security and Medicare taxes (FICA)

Reporting rules:

Employees must report tips to their employer if they total $20 or more per month.
Employers include reported tips on Form W-2.
Self-employed workers report tips on Form 1040 and, if needed, Form 4137 for unreported tips.

Failing to report tips can lead to penalties and interest, so accurate records are essential.

Q3: What is the “No Tax on Tips” deduction?
A3: Starting in 2025 through 2028, a new tax provision allows eligible employees and self-employed workers to deduct up to $25,000 of qualified tips from taxable income.

Starting in 2025 through 2028, a new tax provision allows eligible employees and self-employed workers to deduct up to $25,000 of qualified tips from taxable income.

Key points:

Applies to occupations that regularly receive tips, as defined by the IRS by December 31, 2024.
Tips must be properly reported on Form W-2, Form 1099, or Form 4137.
Self-employed individuals cannot deduct more than their net income from the business where tips were earned.
Phase-out: For higher earners, the deduction decreases by $100 for every $1,000 above:
- $150,000 MAGI (single)
- $300,000 MAGI (married filing jointly)

Q4: How do I report and track tips for the deduction?
A4: To comply and maximize the deduction:

1. Keep a daily log of tips (cash, card, pooled).
2. Report all tips to your employer if you are an employee.
3. Self-employed or unreported tips: file Form 4137.
4. Track total tip income to claim the No Tax on Tips deduction accurately.

Accurate records help both IRS compliance and tax savings.

Q5: Who benefits from this deduction?
A5:

Restaurant servers, bartenders, hairstylists, taxi drivers, and other occupations that regularly receive tips.
Both employees and self-employed workers in qualifying occupations.
Taxpayers with MAGI below the phase-out thresholds for maximum benefit.

Who may not qualify:

Workers in occupations not regularly tipped.
Independent contractors in non-tipping trades.
High-income earners above the phase-out limits.

Q6: Why does this matter?
A6: Tips are a significant part of income but are fully taxable. The “No Tax on Tips” deduction allows eligible workers to:

Reduce taxable income
Save potentially thousands in federal income taxes
Keep more of their earnings from tipped work

Staying informed and keeping detailed records is the key to maximizing this tax benefit.

Article History

v1.0 (May 19, 2025): Initial publication of the article