No tax on tips, explained

The deduction for qualified tips was created by the One Big Beautiful Bill Act for tax years 2025 through 2028. It is claimed on Schedule 1-A and does not require itemizing. Three questions decide what it is worth to you: whether your tips qualify, how much you earn in total, and whether your state follows along.

What counts as a qualified tip

A qualified tip has to meet all of these:

• It is voluntary. The customer decides whether to tip and how much. Automatic service charges, such as an added gratuity on a large table, are wages, not tips, even if the menu calls them a gratuity.
• It is paid in cash or by card, including tips shared through a tip pool or tip-sharing arrangement.
• It is earned in an occupation the Treasury lists as customarily receiving tips before 2025. The list covers restaurant and bar staff, hotel and casino workers, hairdressers, delivery drivers, rideshare drivers, entertainers and many others.
• It is reported. For employees that means reported to the employer and shown on the W-2; for the self-employed, reported on the return.

Tips earned in a business in a specified service trade, such as health, law or financial services, do not qualify. If your tips are listed separately on your W-2 or on an employer statement, that is the figure to start from.

A server’s year

A server earns $16,000 of hourly wages and $24,000 of reported card and cash tips, so the W-2 shows $40,000 of wages. Filing single, the standard deduction removes the first part of that income and the rest is taxed in the 12% bracket and below.

The whole $24,000 of tips is under the cap, so it is all deductible. That removes the server’s federal income tax entirely: the saving is $2,620, which is every dollar of income tax that would otherwise have been due.

What does not change is FICA. The server still pays Social Security and Medicare on every reported tip, $1,836 on the tips alone at 7.65%. Those payroll taxes build the earnings record that sets future Social Security benefits, which is one reason not to underreport tips even now that they are mostly free of income tax.

The cap

The deduction is capped at $25,000 a year per return. Unlike the overtime deduction, the cap is the same for single and joint filers, so a married couple who both work for tips share one $25,000 limit.

A bartender in a busy downtown bar reports $34,000 of tips on top of $20,000 of wages. The deduction stops at $25,000, and the other $9,000 of tips is taxed like ordinary wages. The saving is $3,000.

A worker who earns both qualified tips and qualified overtime can take both deductions. The overtime cap, $12,500 for a single filer, is separate.

The phase-out

The cap shrinks by $100 for every full thousand dollars of modified adjusted gross income above $150,000, or $300,000 on a joint return.

Take a tipped sommelier with $140,000 of other wages and $25,000 of qualified tips. Income comes to $165,000, and the deduction is cut by $1,500 to $23,500. It still saves $5,640 because each dollar of it comes out of a higher bracket. For a single filer with a full cap of tips the deduction reaches zero at $400,000; for a joint return, at $550,000.

Married filing separately gets nothing

A married person who files separately cannot take the deduction at all: it is $0 whatever the tips. Couples who would otherwise file separately, for example to keep student loan payments based on one income, should run both ways before deciding. The tips deduction alone can outweigh the reasons for filing apart.

What is still taxed

• Social Security and Medicare on all reported tips, as above. Employers also pay their half on tips, and many restaurants claim a business credit for it.
• State income tax, unless your state has adopted its own tips deduction. A handful have; most have not, and some states that conform to federal income definitions are still deciding. Our state paycheck pages show each state’s treatment.
• Unreported tips. The deduction applies only to tips you report. Unreported cash tips are still taxable, with penalties if they are found.

Getting the saving in each paycheck

Tips paid by card usually run through payroll, and the employer withholds on them as wages. Without a W-4 change, the deduction shows up as a larger refund.

If your tips are steady, enter the expected deduction in Step 4(b) of Form W-4. The server above is paid every two weeks with about $923.08 of tips a paycheck; federal withholding would fall from $100.77 to $0.00 a paycheck. Seasonal workers and anyone whose tips swing from month to month should be more cautious, because a Step 4(b) figure that turns out too high leaves a bill in April.

Records worth keeping

Keep the daily tip record that IRS Publication 531 describes, or the tip report your employer’s point-of-sale system produces. It shows which tips were voluntary and how much went out in tip-outs to other staff. Tips you pay out to bussers or barbacks are not your tips; the qualified figure is what you keep. If the W-2 and your own records disagree, ask payroll to correct the W-2 before you file.

Every figure on this page is computed by the same code as our calculators. How we calculate.