8522.1 / What is the temporary deduction for tip income?
Editor's Note: The IRS has confirmed that 2025 will be treated as a transition year with respect to employer reporting obligations. Pursuant to Notice 2025-62, employers will not be penalized for failing to provide a separate accounting of any amounts reasonably designated as cash tips or the occupation of the person receiving these tips. The relief applies only for the 2025 tax year, in recognition that employers may not have the necessary information or systems in place to comply with the OBBB reporting obligations. The IRS has also announced that Forms W-2 and 1099 for the 2025 tax year will not be updated to account for the OBBB-related changes. The IRS has, however, released a Schedule 1-A that will be used to calculate the deduction. See heading below for additional employee-side transition relief for 2025.
The OBBB created a temporary deduction for up to $25,000 in qualified tip income (the $25,000 limit applies to both single and joint filers).[1] The deduction only applies for tips received in an occupation where tipping is traditional and customary.
"Tips" for this purpose include amounts that are (1) paid voluntarily, (2) not subject to negotiation and (3) determined by the payor. Both W-2 employees and independent contractors qualify for the deduction. The deduction is allowable regardless of whether the taxpayer itemizes or takes the standard deduction. The Treasury Department has released a preliminary list of occupations that qualify for the deduction, including (but not limited to): bartenders, wait staff and servers, chefs and cooks, hosts and hostesses, dishwashers, dancers, gambling dealers, musicians, digital content creators, ushers, baggage handlers, hotel concierges and clerks, housekeepers, home maintenance and repair workers, home landscaping and groundskeeping workers, home electricians and plumbers, home heating and air conditioning mechanics and installers, personal care and service workers, private event planners. Tip income does not qualify for the deduction if they are received in the course of certain specified trades or businesses, including health, performing arts, and athletics.
The law builds in a safeguard so that the deduction is only available if tipping was a "traditional and customary" method of compensating the employee prior to the 2025 tax year (i.e., businesses cannot modify their compensation structures to recharacterize traditional wages as "tips").
To be deductible, the tips must be received by a taxpayer who was working in a listed occupation and the tips must be "qualified tips".The IRS has now provided four key requirements for a tip to be "qualified".Qualified tips must be paid in cash or a cash equivalent (including credit cards, gift cards and electronic settlement/mobile payment apps denominated in cash (excluding most digital assets).The tips must be received from customers or via a mandatory or voluntary tip sharing arrangement (i.e., a tip pool).The tips must be paid voluntarily and not be negotiable.Certain automatic service charges are expressly excluded.Specifically, when a restaurant imposes a mandatory service charge for large parties and distributes the amounts to employees, the customer has no option to modify or decline to pay the amount, the amounts are not treated as qualified tips.Amounts received for illegal activities are also not qualified tips.
Highly compensated employees are not eligible for the deduction.The amount of the deduction is reduced by $100 for every $1,000 by which the taxpayer's modified adjusted gross income exceeds $150,000 ($300,000 for joint returns).
If the taxpayer owns their business, the tip deduction is limited to their net business income (meaning gross business-related income minus otherwise allowable business deductions).
The deduction is temporarily available for tax years 2025 through 2028. A Social Security number is required for a taxpayer to claim the deduction. The IRS has released a revised draft Form W-2. Employers must include the total amount of cash tips reported by the employee, as well as the employee's qualifying tipped occupation, on the Form W-2 (using boxes 12 and new 14b) beginning in 2026. For 2025, the IRS directed employers to use a reasonable method to approximate the amounts of an employee's qualified tips.
Notice 2025-69: Transition Relief for 2025
Recognizing the challenges that employees will likely face in claiming the deduction for qualified tip income in 2025 due to employer-side transition relief on separately accounting for that tip income, the IRS also offered transition relief for employees. For tax year 2025, the IRS gave employees several options on how to claim the deduction.[2]
The employee can:
- Use the total amount of Social Security tips reported in box 7 of their Form W-2,
- Use the total amount of tips reported by the employee to the employer on all Forms 4070, Employee's Report of Tips to Employer (or a similar substitute form), or
- If an employer voluntarily chooses to report the amount of an employee's cash tips in box 14 of Form W-2 (or on a separate statement), the employee may use this amount in determining the amount of qualified tips for tax year 2025.
Additionally, employees may include any amount listed on line 4 of the 2025 Form 4137 filed with their 2025 income tax return (and included as income on that return).
Also in Notice 2025-69, the IRS has offered several examples for individual taxpayers who receive qualified cash tips during 2025, yet do not receive a separate accounting from their employer due to the IRS' employer-side transition relief. Because Forms W-2 and 1099 are unchanged for 2025, individual taxpayers should look to the examples for guidance on how to claim the deductions for tip and overtime income.
The IRS also announced that there will be a transition period for purposes of IRS enforcement and administration for the "specified service trade or business requirement" (SSTB). Under the OBBB, tips are not "qualified", and therefore not deductible, if they are received in the course of a trade or business that is an SSTB. For most employees, that determination will hinge on whether their employer is an SSTB, and they received the tips in the course of employment with that employer.
By way of transition relief, the IRS announced that until January 1 of the first calendar year following the issuance of final regulations on determining whether a trade or business is a specified service trade or business Section 224 purposes and required employer information reporting, the IRS will treat the employee as having received tips in the course of a trade or business that is not a specified service trade or business. That's only true if the employee works in an occupation that customarily and regularly received tips on or before December31, 2024 (a list has been released by the Treasury Department).
[1] IRC § 224, as created by the 2025 OBBB.
[2] Notice 2025-69.