Treasury Department Clarifies “No Tax On Tips” Eligibility

By: William L. Bricker, Juliya L. Ismailov, and Matthew Crawford

The One Big Beautiful Bill Act (OBBBA), enacted on July 4, 2025, has a number of important new provisions including the new I.R.C. § 224, “no tax on tips,” and I.R.C. § 225, “no tax on overtime.” There have been recent developments related to the new I.R.C. § 224, “no tax on tips.”

On August 27, the media obtained a “deliberative, preliminary” list of  occupations that would qualify for “no tax on tips” treatment. The list includes a broad range of job categories such as waiters, entertainers, and golf caddies. The Treasury Department stated it will review this preliminary list further before issuing an official list as part of proposed regulations to the new statute, I.R.C. § 224, as well as a separate list of ineligible occupations in fields such as health care, the performing arts, and athletics.

Tips have always been includible in gross income, though one wonders whether tips were included.  I.R.C. § 224 allows a deduction from gross income for “qualified tip income” up to $25,000.  The deduction is not subject to the limitations that apply to itemized deductions. The deduction phases out gradually when the taxpayer’s adjusted gross income exceeds $150,000. The phase out is $100.00 for each $1,000.00 of modified adjusted gross income in excess of $150,000.00. Thus, the I.R.C. § 224 elimination of “tax on tips” fully phases out at $400,000.

To claim the deduction, workers must report tip income to their employer. The employer must include the “tips” on the worker’s Form W-2 or Form 1099. Thus, reported tips increase Social Security and Medicare wages, which are subject to (i) in the case of Form W-2, a 7.65% tax for each of the employee and employer,[1] and (ii) in the case of Form 1099, a 15.3% tax on the independent contractor. Thus, the benefit from the qualified tips deduction might be partly offset by higher Social Security and Medicare withholding.

Most provisions of the OBBBA take effect next year, but the “no tax on tips” rule is retroactive to January 1, 2025.

State and Local Tax

I.R.C. § 224 received bipartisan support. Many state and local taxing authorities (e.g., New York State and City) base a taxpayer’s tax liability on federal adjusted gross income, which already accounts for the deduction of tip income. Federal adjusted gross income is gross income less the I.R.C. § 224 deduction. Therefore, states that use federal adjusted gross income as their base would automatically allow the deduction for qualified tip income. We are not aware of any state that has indicated an intention to deviate from the new federal statute.

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[1] Social Security withholding does not apply to income beyond a certain threshold, which increases annually for inflation. In 2025, the threshold is $176,100. There is no similar threshold for Medicare withholding.