Tip Deduction, What Taxpayers Need to Know for 2025

In 2025, Congress created a new, temporary deduction aimed at workers who earn tips. The IRS has now issued proposed regulations that define who qualifies, what counts as a “tip,” how the dollar cap and income phase-outs work, and what employers need to document.

In short: voluntary customer tips can generate a deduction (separate from payroll tax rules), but automatic service charges and certain service businesses are carved out. Final details may shift, but this framework shows how taxpayers and employers should start preparing.

Fast Facts:

• Deduction: up to $25,000 per return (same cap for MFJ)

• Phase-out begins at $150,000 MAGI (single) / $300,000 (MFJ)

• Applies to tax years 2025–2028

• Status: Proposed regulations (details may change when finalized)

Who May Qualify:

• You work in one of 68 listed tipped occupations (e.g., servers, bartenders, barbers, etc.).

• Your employer is not an SSTB (specified service trade or business like athletics or performing arts). If it is, the deduction generally doesn’t apply.

• SSTB status matters. If the business is an SSTB, employees’ tips likely won’t qualify—even if the workers themselves are in a listed tipped occupation.

What Counts as a “Qualified Tip”

• Voluntary amounts given by customers.

• Paid in cash or cash-equivalents (check, credit/debit, standard electronic payments, gift cards, fixed-value tokens).

• Tips received directly or via tip pools/shares.

What Does Not Count

• Automatic service charges added by the business (e.g., mandatory 18% line).

• Amounts connected to illegal activity.

How You’ll Claim It

• IRS has previewed a draft Schedule 1-A to claim new deductions (including this tip deduction).

• Draft 2026 Form W-2 includes updated tip reporting fields.

• The IRS may publish transition guidance for 2025 (e.g., when systems didn’t separately track tips vs. other income).

Practical Next Steps

For Workers

• Track tips by payment type and keep evidence they were voluntary (POS reports, daily logs, copies of receipts).

• Confirm your occupation is on the IRS list and your employer is not an SSTB.

• Watch your MAGI—the benefit phases out at higher incomes.

For Employers

• Review menus/invoices for mandatory service charges (those are not tips).

• Tighten tip-pool documentation and POS reporting to distinguish tips vs. service charges.

• Coordinate with payroll to align W-2 coding and be ready for Schedule 1-A support.

• Monitor final regulations and any 2025 transition relief.

SLT Note: These rules are proposed and could change before final adoption. This overview is general information and not tax advice. For a personalized review, contact SLT.