Congress created a valuable new tax break for tipped workers under the One Big Beautiful Bill Act. The No Tax on Tips deduction applies retroactively beginning January 1, 2025, and the IRS has designated 2025 as a transition year. As a result, the deduction operates differently for 2025 than for later years.
You, your child, or someone you know works in a business (e.g., a fast-food restaurant, Uber, or Lyft) that receives tips. Not having to pay tax on their tips is a significant advantage, as most taxpayers in these vocations need to minimize expenses. You should also be aware that the Franchise Tax Board (FTB) has not opted to conform to many of the provisions of the OBBBA. The FTB does not follow the new federal “no tax on tips” policy. While a federal deduction for qualified tips is available for tax years 2025-2028, California has explicitly opted out of this specific tax break, meaning tips remain fully taxable for state income tax purposes.
For tax years 2025 through 2028, taxpayers who work in one of 68 customarily tipped occupations may exclude up to $25,000 annually of voluntarily paid cash tips from taxable income. The deduction begins to phase out when modified adjusted gross income exceeds $150,000, or $300,000 for joint filers. Only tips that the taxpayer reports to the IRS qualify for the deduction.
For employees, employers report tips on Form W-2, or employees report unreported tips to the IRS on Form 4137.
The IRS did not revise Forms W-2 or 4137 for 2025 to separately identify qualifying tips. Because of this limitation, the IRS does not require employers to track qualifying tips on the 2025 Form W-2 separately.
Employees may determine their qualifying tips by using Social Security tips shown in box 7 of Form W-2, tip reports submitted to the employer on Form 4070, employer-provided tip summaries, and any unreported tips reported to the IRS on Form 4137.
Independent contractors face fewer reporting obstacles for 2025. Payors and payment processors, such as PayPal or Venmo, do not need to report tips on Form 1099-NEC or Form 1099-K separately. Independent contractors may determine qualifying tips using earnings statements, receipts, point-of-sale reports, daily tip logs, payment processor records, or similar documentation. Contractors may also include tips paid in cash, provided they maintain adequate records.
The law generally denies tip deductions for income earned in a specified service trade or business (SSTB), such as health, law, accounting, consulting, financial services, athletics, or performing arts. However, the IRS has delayed enforcement of this no-SSTB rule until it issues final regulations. As a result, the IRS will not apply the rule for 2025 or 2026. Before this change, I could not deduct the tips I received in my tax practice!! (That is a joke, folks – I do not get tips in my line of work, except perhaps the name of some horse that is poised to win a race at Santa Anita!)
This delay significantly expands eligibility. Any employee or independent contractor in a customarily tipped occupation may claim the deduction for 2025, regardless of the employer’s or contractor’s SSTB status. This relief benefits many workers, including entertainers, digital content creators, and massage therapists.