Unpacking the "No Tax on Tips" Provision in the One Big Beautiful Bill Act
The "Big, Beautiful Bill Act" (H.R. 1) introduces a significant change for tipped workers and their employers: a new deduction for qualified tips. This provision aims to provide tax relief for middle-class families and workers. Understanding the specifics of this new tax law is crucial for both individuals who receive tips and businesses responsible for reporting them.
What is the "No Tax on Tips" Deduction?
The Act introduces Section 224 to the Internal Revenue Code of 1986, allowing a deduction for "qualified tips" received during the taxable year. This deduction is available for tips included on official statements furnished to the individual or reported by the taxpayer on Form 4137 (or its successor).
Who Qualifies for the Deduction?
To qualify, individuals must receive cash tips in an occupation that "customarily and regularly received tips on or before December 31, 2024". The Secretary of the Treasury is mandated to publish a list of such occupations within 90 days of the Act's enactment.
What Doesn't Qualify?
The deduction has specific exclusions:
Voluntary Payment: The amount must be paid voluntarily without any consequence for nonpayment, not subject to negotiation, and determined by the payor.
Specified Service Trade or Business Exclusion: Tips received in a "specified service trade or business" (as defined in Section 199A(d)(2)) do not qualify. This also applies to employees if their employer's trade or business is a "specified service trade or business."
Other Requirements: Additional requirements may be established by the Secretary through regulations or other guidance.
Income Limitations and Phase-Outs
The "no tax on tips" deduction is subject to limitations based on the taxpayer's income:
Maximum Deduction: The deduction cannot exceed $25,000 for any taxable year.
Adjusted Gross Income (AGI) Phase-Out: The allowable deduction is reduced by $100 for every $1,000 (or portion thereof) by which the taxpayer's modified AGI exceeds $150,000 ($300,000 for a joint return). Modified AGI includes adjusted gross income increased by any amount excluded from gross income under Section 911, 931, or 933.
Key Details for Taxpayers and Employers
Non-Itemizers Benefit: Even if an individual does not itemize deductions, they can still claim this deduction.
Social Security Number (SSN) Requirement: To claim the deduction, the taxpayer must include their SSN on their tax return.
Married Individuals: If the taxpayer is married, the deduction only applies if they file a joint return.
Coordination with Qualified Business Income: This deduction will not be taken into account when calculating qualified business income under Section 199A.
Termination: This deduction is temporary and will not be allowed for any taxable year beginning after December 31, 2028.
Reporting Requirements for Employers
The Act also amends existing reporting requirements to ensure proper tracking of cash tips.
Form W-2 (and other statements): Employers are now required to include the total amount of cash tips reported by the employee and the employee's occupation on statements furnished to individuals, such as Form W-2.
Payments to Non-Employees: For payments made in the course of a trade or business to non-employees, a separate accounting of reasonably designated cash tips and the recipient's occupation must be provided to both the Secretary and the payee.
Third-Party Settlement Organizations: These organizations must also report the portion of reportable payment transactions reasonably designated as cash tips and the recipient's occupation.
Withholding: The Secretary of the Treasury will modify withholding procedures to account for this new deduction for taxable years beginning after December 31, 2025.
Transition Rule
For cash tips required to be reported for periods before January 1, 2026, those required to file returns or statements may approximate a separate accounting of cash tips using any reasonable method specified by the Secretary.
Conclusion
The "no tax on tips" provision introduced by the "Big, Beautiful Bill Act" represents a notable tax benefit for eligible tipped workers. Understanding the nuances of what qualifies, the income limitations, and the new reporting requirements is essential for maximizing this benefit and ensuring compliance. Employers, in particular, should prepare to adjust their payroll and reporting systems to meet these new mandates.