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Part 2 – Tips Excluded from Income
Certain employees and independent contractors may be eligible to deduct tips from their income for tax years 2025 through 2028 under provisions included in the One Big Beautiful Bill. The deduction is capped at $25,000 per year and begins to phase out at $150,000 of modified adjusted gross income ($300,000 for joint filers).
Importantly, the deduction applies only for income tax purposes, not for FICA taxes. Only tips that are properly reported as income may be deducted, and only if they qualify as "qualified tips" under the new rules.
What Are "Qualified Tips"?
To qualify for the income tax deduction, a tip must meet specific criteria. A "qualified tip" must be:
- Paid voluntarily by the customer
- Free from compulsion, with no adverse consequence for nonpayment
- Determined solely by the customer
For example, many restaurants automatically add an 18% gratuity for parties of six or more. That amount is not a qualified tip. If a customer voluntarily adds an additional 5%, that additional amount may qualify, but the mandatory 18% does not.
Similarly, point-of-sale (POS) systems must allow customers to decline a tip. If a POS device prevents a transaction from being completed unless a tip is selected, the tip is not considered voluntary and therefore is not qualified.
Who Is Eligible to Deduct Tips?
Only workers in certain occupations are eligible to deduct tips from income. Proposed Treasury Regulations limit eligibility to occupations in which tipping is customary and include a defined list of qualifying roles.
Some occupations commonly associated with tipping are included, such as:
- Restaurant workers
- Valet car parkers
- Hair stylists and manicurists
- Spa workers
- Golf caddies
Less expected occupations also appear on the list, including digital content creators and certain entertainment-related roles such as musicians, singers, comedians, and dancers.
However, specified service businesses are excluded. These include professions such as law, accounting, health care, investment management, sports, and the performing arts. As a result, workers engaged in those fields generally may not deduct tips.
The Specified Service Business Carve-Out
The exclusion for specified service businesses applies at the business level, not the individual worker level, leading to nuanced outcomes.
For example:
- A musician receiving tips while performing in a hotel lobby may deduct those tips because the hotel is not a performing arts business.
- A comedian performing at an entertainment venue may not deduct tips because the business itself is engaged in the performing arts.
- Waiters and bartenders employed directly by a performing arts venue may be ineligible.
- However, if those same workers are employed by a third-party foodservice operator providing concessions at a theater, the tips may qualify because the employer is not a specified service business.
Yes — these rules can require very fine distinctions, and careful analysis will be essential.
How This Fits with Other Tax Changes
This article builds on our prior discussion of overtime-related
tax changes under the One Big Beautiful Bill. For a breakdown of
the new overtime tax deduction rules and employer reporting
obligations, see Part 1 – New Overtime Tax Rules
Employers & Employees Need to Know:
https://scarincihollenbeck.com/law-firm-insights/overtime-tax-deduction-one-big-beautiful-bill
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
