The One Big Beautiful Bill Act (OBBBA) introduces several significant changes for taxpayers, including new federal income tax deductions for qualified tips, effective for tax years 2025 through 2028. Some of these provisions are retroactively effective as of January 1, 2025, impacting tax reporting. The OBBBA builds upon and modifies elements of the 2017 Tax Cuts and Jobs Act (TCJA), many of which were set to expire at the end of 2025.
Important Considerations
While these deductions offer potential tax savings, there are two important considerations:
- Detailed qualifications: The deductions come with specific eligibility requirements.
- Delayed impact: The benefits will primarily be realized when filing annual tax returns, rather than through immediate payroll adjustments.
Definition of Qualified Tips
- Eligibility: To claim the deduction, a worker must be in an occupation on the list of qualified occupations and receive qualified tips. The proposed regulations provide a definition of qualified and non-qualified tips, which includes the factors below.
Qualified tips must be:
- Paid in cash or an equivalent medium, such as check, credit card, debit card, gift card, tangible or intangible tokens that are readily exchangeable for a fixed amount in cash or another form of electronic settlement or mobile payment application (excluding most digital assets) denominated in cash.
- Received from customers or, in the case of an employee, through a mandatory or voluntary tip-sharing arrangement, such as a tip pool.
- Paid voluntarily by the customer and not be subject to negotiation.
Qualified tips do not include some service charges. For instance, if a restaurant imposes an automatic 18% service charge for large parties and distributes that amount to waiters, bussers and kitchen staff, if the charge is added with no option for the customer to disregard or modify it, the amounts distributed to the workers are not qualified tips.
Any amount received for illegal activity, prostitution services, or pornographic activity is not a qualified tip.
Deduction Limits
- Cap: The deduction is limited to $25,000 of qualified tips.
- Phase-out: Tip deductions phase out completely for taxpayers with a modified adjusted gross income (MAGI) exceeding:
- $150,000 for single filers.
- $300,000 for married taxpayers filing jointly.
Additional Considerations
Impact on Federal Taxes
The tip deduction reduces taxable income rather than being categorized as an itemized expense. This means taxpayers can benefit from the deduction regardless of whether they itemize or use the standard deduction. However, the deductions only apply to federal income taxes and do not affect Medicare or Social Security taxes.
Timing of Tax Benefits
Unlike previous tax reductions that adjusted payroll withholding tables to increase take-home pay, this deduction will be realized when taxpayers file their annual Form 1040. As a result, employees may see larger refunds when filing their 2025 tax returns, rather than immediate increases in their paychecks.
RKL is here to help you navigate these changes to the way you file your taxes. Contact us today.
