"No Tax on Tips" Provision in the One Big Beautiful Bill Act

Written By Jason Hamilton

The "No Tax on Tips" provision, established under Section 70201 of the One Big Beautiful Bill Act, provides groundbreaking tax relief for millions of tipped workers across the United States. Enacted to support occupations where tipping is a customary part of the job, this provision allows individuals to deduct qualified cash tips from their taxable income, up to a set limit. By doing so, it recognizes the hard work of tipped employees and provides them with meaningful financial relief.

This measure, effective for taxable years starting after December 31, 2024, and running through December 31, 2028, represents a significant step toward reducing the tax burden on service industry workers and incentivizing accurate tip reporting.

How Does the "No Tax on Tips" Provision Work?

The provision allows tipped workers to deduct qualified tips from their taxable income, provided they are reported accurately and meet specific criteria. This deduction applies whether the taxpayer itemizes deductions or takes the standard deduction, making it accessible to more individuals.

Key aspects of the provision include:

  1. A deduction of up to $25,000 annually for qualified tips.

  2. An income-based phaseout, where deductions are reduced for higher-income earners.

  3. Specific rules for what qualifies as a "tip," ensuring fairness and preventing abuse of the deduction.

Key Features of the "No Tax on Tips" Provision

1. Deduction for Qualified Tips

  • Definition: Qualified tips are cash tips received in occupations where tipping is customary (e.g., servers, bartenders, hairstylists, etc.).

  • Deduction Limit: The maximum deduction is capped at $25,000 per year.

  • Eligibility: Tips must be reported on tax forms or payroll records, such as Form 4137 or statements under IRS Sections 6041, 6041A, or 6050W.

2. Income-Based Phaseout

  • For individuals earning more than $150,000 ($300,000 for joint filers), the deduction is reduced:

    • $100 reduction for every $1,000 of income above the threshold.

  • Adjusted Gross Income (AGI) is modified to include amounts excluded under foreign income exemption rules (Sections 911, 931, or 933).

3. What Qualifies as a Tip?

  • Qualified Tips must:

    • Be paid voluntarily and determined by the payor (i.e., the customer).

    • Not result from negotiation or mandatory charges.

    • Be associated with a business not classified as a specified service trade or business (e.g., consulting, law, etc.).

  • Cash Tips: Includes tips paid in cash, by card, or through tip-sharing arrangements.

4. Exclusions

  • Tips received in businesses classified as specified service trades or businesses are not deductible.

  • Improperly documented or unreported tips do not qualify.

5. Social Security Number Requirement

  • Taxpayers must include their Social Security Number (SSN) on their tax return to claim the deduction.

6. Joint Filers

  • Married individuals must file a joint return to be eligible for the deduction.

7. Regulations to Prevent Abuse

  • The IRS will issue regulations to prevent the reclassification of income as tips to exploit this deduction.

Additional Provisions Supporting Tipped Workers

1. Extension of Tip Credit to Beauty Services

  • The existing employer tip credit, which offsets payroll taxes for tipped employees, is now extended to workers in beauty service industries, including:

    • Haircare and barbering.

    • Nail care.

    • Esthetics (e.g., facials and skincare).

    • Body and spa treatments.

2. Reporting Enhancements

  • Employers and payment processors must report cash tips separately on tax forms, ensuring transparency and proper classification of income.

  • Reporting requirements now include:

    • Occupations of individuals receiving tips.

    • Separate accounting of amounts designated as tips.

3. Published List of Tipped Occupations

  • The Secretary of the Treasury will publish a list of occupations where tipping is customary (as of December 31, 2024) to guide taxpayers and employers.

4. Withholding Adjustments

  • Beginning in 2026, IRS withholding tables will account for the deduction, providing immediate tax relief to eligible workers.

Key Points of the "No Tax on Tips" Provision

Deduction for Tips

  1. Up to $25,000 annually can be deducted for qualified tips.

  2. Tips must be documented and reported on IRS-approved forms or payroll records.

Income-Based Limits

  • Deduction begins to phase out at:

    • $150,000 AGI for individuals.

    • $300,000 AGI for joint filers.

  • Reduced by $100 for every $1,000 over the income limit.

Eligible Tips

  1. Must be:

    • Voluntary and not mandatory.

    • Paid in cash, by card, or under a tip-sharing arrangement.

  2. Cannot come from specified service trades or businesses (e.g., consulting).

Expanded Tip Credit

  1. Employers in beauty and spa industries can now claim a payroll tax credit on tips paid to employees.

Reporting and Compliance

  1. Employers must:

    • Report tips separately on forms (e.g., Form 6041, 6041A).

    • Include the occupation of the tip recipient.

  2. Payment processors must disclose tips on third-party settlement forms (e.g., Form 1099-K).

IRS Oversight

  1. The IRS will issue regulations to prevent abuse or improper classification of income as tips.

  2. Taxpayers must include their SSN to claim the deduction.

Timeline

  1. Effective Date: Tax years starting after December 31, 2024.

  2. End Date: Deduction expires for tax years after December 31, 2028.

Impact of the "No Tax on Tips" Provision

  1. Relief for Service Workers

    • Reduces taxable income for millions of tipped workers, providing meaningful financial relief.

    • Encourages accurate tip reporting by offering a tangible tax benefit.

  2. Support for Beauty Service Industries

    • Extending the tip credit to beauty and spa employers incentivizes hiring and benefits workers in this growing sector.

  3. Economic Benefits

    • By increasing disposable income for tipped workers, the provision may stimulate consumer spending in local economies.

  4. Simplified Reporting

    • Enhanced reporting requirements ensure fairness and transparency, benefiting workers, employers, and the IRS.

The "No Tax on Tips" provision is a key victory for service industry and tipped workers, recognizing their contributions and providing substantial tax relief. With its robust safeguards and clear guidelines, this measure balances benefits for workers with accountability to prevent abuse. For service employees, this is a game-changer that puts more money back in their pockets while encouraging ethical reporting practices.

Jason Hamilton
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