Here's a breakdown of the recently-enacted "No Tax on Tips Act"
What it does:
The new law creates a federal income tax deduction for “qualified tips” earned in tipped occupations, effective for the 2025 tax year (so you’ll file in early 2026).
The deduction allows eligible workers to deduct up to $25,000 in tip income from their federal taxable income annually.
It applies whether you take the standard deduction or itemize, because it’s an “above-the-line” deduction.
It’s processed as a reduction of income, not a full exclusion: you still report the tip income, but you subtract (deduct) up to the limit.
What it doesn’t
do (and other limitations):
It doesn’t exempt the tip income from payroll taxes (Social Security and Medicare) — those still apply to tip income.
It’s for federal income tax only; state and local taxes may still apply based on your state.
It’s temporary — the deduction is scheduled to cover tax years 2025 through 2028.
Not all tip income qualifies. It must meet certain criteria (see below).
There are income-phaseouts: higher earners get reduced benefit or may not qualify at all.
Key eligibility and rules you must know:
Here are the important details if you earn tips:
Qualifying tips:
Tips must be voluntarily given by the customer, not mandatory service charges or auto-gratuities added by the employer.
Tips received in cash, debit/credit card, or through a tip-sharing program count — as long as they are properly reported.
The person must work in an occupation that “customarily and regularly receives tips” (the Treasury/IRS will publish a list of eligible occupations).
Income limits / phase-outs:
A single filer’s modified adjusted gross income (MAGI) must be $150,000 or less to get full deduction. For joint filers it’s $300,000 or less
for full deduction.
As income rises above those thresholds, the deduction phases out. For example, for singles it phases out entirely at ~$400,000 MAGI.
If you’re self‐employed, you can deduct up to your net tip-based business income (so you can’t deduct more than you earned).
Other things to track:
You must report your tip income (on W-2, 1099, or Form 4137 if required). Undeclared tips won’t qualify.
The law is retroactive to January 1, 2025 (so tips earned this year should qualify, if you meet other rules).
If you’re married and filing separately, you cannot claim the deduction.
Why this matters for self-employed / tipped workers:
If you are self-employed and receive significant tip income (e.g., hair stylist, rideshare driver with many tips, server who also works independently, etc.), this deduction can reduce your federal taxable income and thus lower your income tax liability.
Because it’s an “above the line” deduction, it can also help reduce your Modified Adjusted Gross Income, which may help you qualify for other tax benefits or avoid phase-outs for other credits.
However, you still must pay FICA / self-employment tax on your earnings, and you still must comply with tip‐reporting rules.
The benefit is limited by the occupation eligibility, amount of tips, and your total income — so you’ll want to carefully track tips and report them accurately.
If you earn tips but already have low taxable income (so you owe little or no federal income tax), the deduction may not have much impact. Experts estimate only a small percentage of tax filings will benefit.