If you’ve ever waited tables, cut hair, delivered food, or worked in any tip-based profession, you know tips aren’t just pocket change—they’re a vital part of your livelihood. For decades, however, tip income has been treated much like wages in the eyes of the IRS: taxable and subject to payroll withholdings.
That’s why the recently passed “One Big Beautiful Bill Act” is generating buzz. It introduces a brand-new, above-the-line tax deduction—up to $25,000 for qualified tips. This shift could be a game-changer for millions of workers in tipping-heavy industries, but as always with tax law, the devil is in the details.
Let’s break it down—past rules, the new law, and what it means for employees, independent contractors, and business owners.
Tip Reporting Before the Change: The Old Rules
Historically, tipped workers had strict IRS obligations:
- Reporting: Employees had to report any tips of $20 or more per month per employer by the 10th of the following month.
- Employer Duties: Employers withheld Social Security, Medicare, and income taxes from reported tips, adding them to the employee’s W-2.
- Penalties for Noncompliance: Failure to report could result in IRS penalties—often 50% of the employee’s share of Social Security and Medicare taxes on unreported tips.
For larger restaurants and similar businesses (10+ employees and customary tipping), employers had an added burden. They had to ensure total reported tips equaled at least 8% of gross sales. If workers reported less, employers had to “allocate” the difference.
There was also a perk for employers: the FICA tip tax credit, claimed on IRS Form 8846, which allowed businesses to offset a portion of their Social Security taxes paid on employee tips above minimum wage thresholds.
What’s New: A $25,000 Above-the-Line Deduction
The One Big Beautiful Bill Act introduces a fresh opportunity:
- Deduction Amount: Up to $25,000 per return (not per individual).
- Timing: Available only between 2025 and 2028.
- Deduction Type: An above-the-line deduction, which reduces your Adjusted Gross Income (AGI).
Why does that matter? Above-the-line deductions apply whether or not you itemize. They also help you qualify for other tax benefits tied to AGI thresholds, like education credits or IRA contributions.
So, if a server earns $40,000 in wages plus $20,000 in tips, and $25,000 of those tips qualify, their taxable AGI could shrink dramatically.
What Counts as “Qualified Tips”?
To qualify, tips must be:
- Given voluntarily
- Not required for service
- Non-negotiable (the payer sets the amount)
- Paid in connection with an eligible trade or business (to be defined by the Treasury)
- In compliance with forthcoming IRS regulations
Importantly, both W-2 employees and self-employed workers (e.g., stylists, rideshare drivers, spa technicians) can benefit—provided their work is in an approved profession. The Treasury Department is expected to release a list of qualifying occupations by October 2025.
Self-Employed? Here’s How It Works
Independent contractors and gig workers must:
- Include tips in business income when filing taxes.
- Deduct tips (up to $25,000) as long as their business is eligible.
- Watch out: if deductions exceed business income, the tip deduction may be limited.
In other words, your tips still count as revenue, but this new rule gives you a valuable offset.
When the Deduction Isn’t Available
Not every taxpayer can claim this benefit. Here are the restrictions:
- Specified Service Trades or Businesses (SSTBs): Professions like healthcare, law, accounting, and consulting (the “reputation/skill-based” fields under Section 199A) are excluded. So, accountants and lawyers don’t qualify.
- High-Income Phase-Out: If your AGI is over $150,000 (single) or $300,000 (joint), the deduction shrinks by $100 for every $1,000 above the threshold.
- Filing Status: Married couples must file jointly to claim.
- Valid SSN Required: Claimants need a work-eligible Social Security Number to qualify.
Expanded Employer Benefits: The FICA Tip Credit Grows
The Act also updates the employer side:
- Old Law: The FICA credit was limited to restaurants and bars.
- New Expansion: It now covers beauty services—hair salons, nail salons, spas, and esthetic services.
That’s big news for salon owners and spa managers who, until now, had no relief from payroll taxes on employee tips.
Why This Matters
This legislation is a major acknowledgment of how the U.S. economy has evolved. From fine dining servers to Uber drivers, tip income is increasingly vital—and often unpredictable. By reducing taxable income at the AGI level, this law gives workers in eligible industries meaningful relief.
At the same time, the employer-side changes encourage fairer treatment across sectors historically left out of the tip-credit conversation.
What Workers and Employers Should Do Next
Tax rules are tricky, especially with a provision this new. Here’s what we recommend:
- For Tipped Workers: Start keeping detailed tip records now. Even with digital apps and card payments, accurate tracking will matter when proving eligibility.
- For Self-Employed Professionals: Plan for both inclusion (tips as income) and deduction (qualified tips up to $25,000).
- For Employers: Review eligibility for the expanded FICA credit—particularly if you own a salon, spa, or other beauty-related business.
- For High Earners: If your AGI nears or exceeds the phase-out thresholds, consider tax planning strategies (e.g., retirement contributions) to preserve the deduction.
Final Thoughts
The One Big Beautiful Bill Act represents a landmark shift in tip taxation. For many tipped workers, it’s the first time the IRS has given significant relief tailored to the nature of their income.
But it’s temporary, it’s complex, and it has strings attached. This is one of those times when professional tax guidance makes a world of difference.
At JS Morlu, we specialize in helping individuals, small businesses, nonprofits, and government contractors navigate complex tax changes. Whether you’re a server, stylist, or business owner adapting to these new rules, our team of CPAs and tax advisors can help you maximize deductions, stay compliant, and keep more of what you earn.
📞 Contact us today for a free consultation and let’s make sure you’re ready to benefit from this historic change.