Tipping the Scales — What the IRS’ New Tip Income Rules Mean for You

If you or your clients work in industries where tips are a regular part of compensation — think restaurants, salons, hospitality, or healthcare — the IRS just made a major change that could put more money back in your pocket.

Thanks to the One Big Beautiful Bill Act (OBBBA), tip income is getting a long-overdue tax update. Here’s what you need to know:

A New Deduction for Tip Earners

Starting with the 2025 tax year, individuals who earn qualified tip income can deduct up to $25,000 annually above the line on their federal tax return. That means tip earners can reduce their taxable income directly — without itemizing.

This deduction is available through 2028, with a phase-out beginning at $150,000 in income for single filers and $300,000 for joint filers.

Who Qualifies?

The IRS defines “qualified tip income” as tips received in occupations that customarily receive tips — including:

·       Cash and credit card tips from customers

·       Tips received through tip-sharing arrangements

Excluded from the deduction are automatic gratuities and service charges. The IRS will release a full list of qualifying occupations soon, so stay tuned.

Reporting Still Matters

Even with the new deduction, tip income must still be:

·       Reported to employers by employees

·       Included on Form W-2

·       Tracked separately from overtime and other pay types

The IRS is not issuing a new W-2 form, but will require additional reporting fields to distinguish tip income from other earnings. Employers will receive transition relief to help implement these changes.

What Employers Should Do Now

If you manage payroll for tipped employees, here are a few steps to prepare:

·       Update payroll systems to track qualified vs. non-qualified tips.

·       Educate employees on the new deduction and reporting requirements.

·       Watch for IRS guidance on occupation lists and reporting formats.

·       Consult your payroll provider to ensure compliance.

Industries like hospitality, retail, and healthcare will be most affected — and most likely to benefit.

The Bottom Line

OBBBA’s tip income provision is a win for workers and a wake-up call for employers. By allowing tip earners to deduct a portion of their income, the IRS is recognizing the unique nature of tipped work — and giving employees a chance to keep more of what they earn.

For payroll teams, this is an opportunity to streamline processes, support compliance, and deliver real value to clients navigating the new rules. We’ll be updating this site as new IRS guidance is released. In the meantime, reach out to your GP advisor if you have any questions!