"No Tax on Tips" (sort of): What Changed, What Has Not, and Now What?

The One Big Beautiful Bill Act (signed on July 4, 2025) introduced an above-the-line deduction for "qualified tips" starting with tax years beginning after December 31, 2024 (thus, calendar year 2025). Eligible workers can deduct up to $25,000 of qualified tips annually, with a phase-out starting at $150,000 MAGI ($300,000 for joint filers). "Qualified tips" include voluntary cash or charged tips, such as tip-sharing, but exclude mandatory service charges. By October 2, 2025, the IRS will publish a list of occupations that "customarily and regularly" received tips on or before December 31, 2024, and will provide transitional reporting relief for 2025. The statute excludes the deduction for SSTBs (e.g., health, law, accounting), including employees of those businesses. Married taxpayers must file jointly to claim it. This deduction is applicable from 2025 to 2028.

What remains unchanged is that tips are still considered wages for FICA purposes. Employers are required to collect and remit Social Security and Medicare taxes on all cash tips, as long as they meet the $20/month reporting threshold. The new law does not alter this requirement. Additionally, the IRS has stated that the withholding tables will remain the same for 2025, meaning employees will experience typical withholding throughout the year and receive the benefit when filing taxes through a deduction. In essence, it is not tax-free on paychecks but rather a year-end deduction against federal income tax.

Expect non-uniform state treatment at first. Some states may conform; others won’t. In California, for example, proposals to create a state-level tips deduction have been introduced but have not become law as of today—meaning tips remain fully taxable for CA income tax until Sacramento acts. If your workforce spans multiple states, plan for mixed rules in 2025.

There are several regulatory unknowns we’re watching. The IRS must still finalize the occupation list, define any safe harbors for W-2/1099 reporting, and clarify anti-abuse rules around recharacterizing wages as tips. Early employer advisories stress the line between true tips and service charges and warn against compensation reshuffles that chase the deduction. Until guidance lands, keep policies conservative and your documentation tight.

Another reality to consider is that since this is a deduction, some low-income workers (who already have no federal income tax liability after the standard deduction) will not receive a cash benefit, while higher-income workers will encounter the phaseout. Additionally, apart from employee benefits, business owners might gain indirectly through the established FICA tip credit rules. Materials from the OBBBA era mention discussions about extending this credit beyond restaurants to include certain beauty services, so it’s advisable to review your eligibility.

So how can Norling Tax & Accounting help? I’ll map which roles in your org are likely to be on the IRS’s qualifying occupations list, separate true tips vs. service charges in your pricing, and coordinate payroll so W-2s show the right amounts when the year closes. On cash-flow and taxes, I’ll model the federal deduction alongside FICA (unchanged), state nonconformity, and any §45B FICA tip credit opportunities, then update quarterly estimates so there are no surprises. Finally, once the Treasury releases the occupation list and reporting rules, I’ll update your tip-pool policy, train managers, and adjust your payroll/point-of-sale exports so your 2025 filings are clean.