OBBBA creates a deduction for qualified tips received by an individual in an occupation which traditionally and customarily receives tips during a given taxable year.
Annual Deduction Limits - While the provision allows for the deduction of tips, it imposes an annual cap of $25,000 on the deduction amount. Notably, this limitation ensures that while taxpayers can benefit from reduced taxable income, there exists a ceiling that balances the provision’s fiscal impact.
Reduction – Income Based - Further complicating the landscape is the income-based reduction rule. For individuals with an adjusted gross income (AGI) exceeding $150,000 or $300,000 for joint filers—the deduction is incrementally reduced by $100 for every $1,000 over the AGI threshold. Tax professionals must analyze their clients' AGI closely to provide precise advice on the extent of deductions permissible under these parameters.
Qualified Tips: Means cash tips received by an individual in an occupation which customarily and regularly receives tips. This is vague enough to cause all sorts of problems. “Cash tips” includes tips received from customers that are paid in cash or charged, and, in the case of an employee, tips received under any tip-sharing arrangement.
Tips shall not include any amount received by an individual unless:
- The tip is voluntary,
- Not subject to any consequence for non-payment,
- Is not negotiable, and the amount is determined by the payer.
- The trade or business receiving the tip is not a specified trade or business under Sec 199A(d)(2) and,
- Such other requirements established by regulations.
Tips in Business Operations:
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Inclusion in Business Income: Tips earned in the course of business activities (apart from employment) must be included as part of the business’s gross income.
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Deductive Eligibility: Tips are also eligible for a business deduction under the established limits ($25,000 Max per year).
- Tip Credit: OBBBA also extended the employer FICA tax tip credit to Beauty Service Businesses and businesses that provide food delivery and serving food if the tipping of customers is customary.
Tip Reporting
- Employer: The employer must report to the employee (and to the SS Administration) on Form W-2:
(1) the total amount of cash tips reported by the employee to the employer under Code Sec. 6053(a), and
(2) The occupation described in Code Sec. 224(d)(1) of the employee who received the tips (Code Sec. 6051(a)(18) as added by the OBBB Act).
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Service Recipient: A service recipient must report qualified tips on the nonemployee payee‘s Form 1099-NEC or Form 1099-K.
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Nonemployee Payees: For nonemployee payees (e.g., independent contractors, freelancers, gig workers, sole proprietors, etc.), the business payer with the reporting requirement must provide the IRS and the applicable payee with a separate accounting of (1) the amounts reasonably designated as cash tips, and (2) the occupation described in Code Sec. 224(d)(1) of the payee who received the tips.
- Bottom Line: The deduction equals the amount of qualified tips received during the tax year that are included on statements that payers must furnish to individual payees.
Other Issues
- If married, taxpayers must file a joint return.
- SSN: Taxpayer must have a valid SSN. If filing jointly both spouse and taxpayer have a valid SSN.
- The deduction is an adjustment to income, available to non-itemizers.
- Secretary of the Treasury shall prepare, within 90days, a list of occupations that customarily receive tips.
- The IRS will need to provide information to businesses on reporting statements that will be required. Watch for IRS notices, FAQs, and other communiques that spell out the new rules
- Deduction available 2025 through 2028
- Excludes tips earned in specified service trades or businesses under Code Sec. 199A(d)(2) (see below)
- A valid, work-eligible Social Security Number (SSN) is required to claim the deduction, which is taken above-the-line. Thus, it is available to both those who itemize their deductions and those claiming the standard deduction.
Specified Service Trades or Businesses: Generally, includes any trade or business described in Sec 1202(e)(3)(A), but excluding engineering and architecture and trades or businesses that involve the performance of services that consist of investment-type activities. Specified service businesses include trades or businesses involving the performance of services in the fields of: health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees, as defined in Reg. 1.199A-5(b)(2).
Effective Date: Taxable years 2025 through 2028.