“No tax on tips:” What you need to know

“No tax on tips” has become a widely discussed topic, especially after the One Big Beautiful Bill Act (OBBBA) was passed in recent legislative sessions. But what does no tax on tips actually mean for workers and tax professionals? For those who earn tips, primarily in the service and hospitality industry, or for tax advisors with clients receiving gratuities, it’s important to understand and follow the impact of this new program.

Beginning with the 2025 tax season, employees who voluntarily receive tips or gratuities will benefit from changes that allow them to reduce their taxable income by excluding eligible tip earnings. While the phrase “no tax on tips” is attention-grabbing, it’s important to note that the program has specific requirements and guidelines that both taxpayers and tax professionals should review carefully. This initiative was passed alongside a set of related tax reforms designed to help reduce the tax liability of those who work overtime, those with active car loans, and older taxpayers.

Tax deductions: A brief introduction

A tax deduction, sometimes called a “tax write-off,” allows taxpayers to reduce their taxable income by subtracting eligible expenses approved by the Internal Revenue Service (IRS), making tax deductions work as powerful tools for lowering the taxes owed each year. They can be used when you incur certain qualifying expenses during the tax year or make contributions to tax-advantaged accounts such as Health Savings Accounts (HSAs) or retirement plans. Both individuals and business owners can improve their financial outcomes by understanding how tax deductions work and maximizing allowable deductions each tax season.

There is a broad spectrum of above-the-line deductions that can be claimed during tax time, illustrating how tax deductions work at different levels. These range from medical expenses to contributions to retirement savings plans, and are reported using 1040 Schedule 1. Above-the-line deductions are deducted from gross income without requiring itemization, which is a major way these tax deductions work to lower your overall tax obligation. For other deductibles, such as standard or itemized deductions, which are often called “below-the-line” tax deductions, the deduction amount is calculated based on your adjusted gross income (AGI) after any above-the-line deductions have been applied. In practice, most taxpayers can maximize annual tax benefits by combining both above-the-line deductions and the standard deduction as part of their overall tax-reduction strategy.

How does “no tax on tips” work?

Technically, even under the new law, tips remain taxable income; however, with the recent “no-tax-on-tips bill” passed as part of the One Big Beautiful Bill Act (OBBBA), tipped workers now benefit from significant new federal tax deductions. Under these updated rules, individuals who earn tips may qualify for a federal income tax deduction for up to $25,000 of qualified tip income. This means that there is effectively no tax on tips up to this threshold for eligible taxpayers.

The mechanics of how tax deductions work under the OBBBA are designed to support those with moderate incomes. Single filers with a Modified Adjusted Gross Income (MAGI) over $150,000 and joint filers above $300,000 will see a gradual phase-out of the deduction, ensuring the greatest benefit goes to lower- and middle-income earners. Worth noting, these provisions also cover certain forms of overtime pay, aligning with the no-tax-on-overtime aspect of the new legislation.

The no-tax-on-tips program began in the 2025 tax year and is scheduled to continue through 2028, making 2029 the final year to claim this deduction unless lawmakers choose to extend the initiative. This unique opportunity could significantly reduce taxable income for many tipped workers by enabling them to leverage targeted federal tax benefits.

Limits of “no tax on tips”

While many tipped workers benefit from the current program in the short term, several important drawbacks should be considered:

• Tips and commissions exceeding $25,000 are still subject to federal taxes, and those making above a certain income threshold will have to subtract from their tax savings.
• The average tax benefit is generally under $1,400, although individuals who earn less in tips will receive proportional deductions.
• Base salaries for tipped employees may stagnate or even decrease due to this deduction program, which could harm those whose earnings are too low to have taxes withheld.
• After 2025, workers in a “specified service trade or business” (SSTB), such as healthcare professionals, attorneys, performers, or others in specialized industries, will no longer be eligible for the no-tax-on-tips benefit.
• The program is set to phase out after 2028.
• State tax deductions may not apply.

Although the no-tax-on-tips provision provides immediate relief for many workers by reducing the tax burden on their reported tips, the benefits may be temporary. Some employees in SSTBs, such as musicians performing at small venues or independent personal trainers, might currently enjoy collecting tax-free tips as business owners, but will lose access to these benefits starting in 2026.

No tax on overtime and other recent legislative updates

Recent updates under the OBBBA have expanded how tax deductions work and introduced several valuable tax breaks, including significant provisions for no tax on overtime pay:

• Taxes on overtime: Eligible taxpayers can now benefit from no tax on overtime earnings by deducting up to $12,500 of qualified overtime pay for single filers and $25,000 for joint filers from their taxable income. The phase-out for this overtime deduction follows similar rules as the tips income deduction, with $100 of the deduction reduced for every $1,000 in income above Modified Adjusted Gross Income (MAGI) limits.
• Autoloan interest deduction: Taxpayers may now include up to $10,000 in U.S.-assembled new car loan interest, paid between 2025 and 2028, as part of their standard deduction options. Used vehicles are not eligible for this particular deduction.
• New senior tax deduction: For those age 65 or older, a higher deduction of up to $6,000 for single filers or $12,000 for joint filers is now available, provided specific income requirements are met. This new senior deduction extends through 2028 and can be claimed by seniors regardless of whether they choose the standard or itemized deduction.

All of these programs can be claimed by filling out Schedule 1-A with your tax return (“Additional Deductions”), which is an attachment to your 1040. These updated tax deduction programs apply to tax years 2025 through 2028. Taxpayers can claim these benefits whether they choose the standard or itemized deductions, making it crucial to understand how tax deductions work when preparing their returns.

What can I do?

If you earn tips, qualify for other new benefits under OBBBA, or are unsure about what benefits are available to you, here are some steps you can take:

1. Read about new programs in the news and updates directly from the IRS for the specifics of each benefit.
2. Make sure that your earnings are accurately reported on your W-2, 1099, or other relevant form, and that “tip occupation codes” are accurate for maximum benefits.
3. Speak to a qualified tax professional to make sure you’re accurately claiming the benefits entitled to you.

The IRS offers many services and recommendations for third-party tax preparation partners to help you navigate your returns and beyond. Qualified individuals may even be able to file their taxes for free with an IRS partner.

Conclusion

Tax policy may seem dry at first glance, but it is ever-changing and dynamic, affecting the lives of everyday people. The 2025 OBBBA brought many changes to tax law, but actual policies are often more nuanced than their associated slogans. By staying up-to-date with recent changes and connecting with experts, you can enter each tax season more informed and ready to maximize your benefits for the year.