For the roughly 4 million Americans who earn a significant portion of their income from tips—restaurant servers, bartenders, hotel workers, rideshare drivers, and countless others—2026 marks a watershed moment in tax policy. The One Big Beautiful Bill Act, signed into law on July 4, 2025, introduced what supporters are calling the most significant tax relief for service workers in decades: the ability to deduct up to $25,000 in tip income annually.
How the No Tax on Tips Deduction Works
The new provision allows employees who receive "qualified tips" to claim an above-the-line deduction on their federal tax returns. This means the deduction reduces your adjusted gross income (AGI), providing a benefit whether you itemize deductions or take the standard deduction.
Qualified tips include:
- Cash tips received directly from customers
- Tips paid through credit and debit card transactions
- Tips received through tip-sharing arrangements
- Tips reported on Form W-2 or Form 1099
To qualify, the tips must be from occupations that "customarily and regularly received tips on or before December 31, 2024." This language effectively grandfathers in traditional tipped professions while preventing abuse of the provision in industries that have only recently adopted tipping.
Income Phase-Outs and Limitations
The deduction isn't unlimited. Key restrictions include:
Maximum Deduction: $25,000 per year for individuals ($50,000 for married couples filing jointly if both spouses have qualifying tip income).
Income Phase-Out: The deduction begins to phase out for taxpayers with modified adjusted gross income (MAGI) exceeding $150,000 for single filers or $300,000 for joint filers. The phase-out is complete at $200,000 for singles and $400,000 for joint filers.
Self-Employment Limit: For self-employed individuals like rideshare drivers, the deduction cannot exceed net income from the business where tips were earned before this deduction is applied.
The Overtime Deduction: A Parallel Benefit
The OBBBA also created a companion provision that many workers may not realize they can claim: the no tax on overtime deduction. Workers can deduct the premium portion of overtime pay—typically the "half" in "time-and-a-half"—up to $12,500 for single filers or $25,000 for joint filers.
Importantly, this only applies to overtime required under the Fair Labor Standards Act (FLSA). More generous overtime provisions under state law or union contracts don't qualify for the federal deduction.
"This combination of tip and overtime deductions represents the most significant tax relief for working-class Americans in a generation. A restaurant worker earning $45,000 with $20,000 in tips could see their federal tax bill drop by $2,000 to $3,000."
— Tax Policy Center analysis
What You Need to Do Now
While the deduction is retroactive to 2025 (those returns filed in early 2026), there are important steps to take:
Track Your Tips Meticulously: Keep detailed records of daily tip income, including cash tips that may not appear on your W-2. The IRS has always required tip reporting, but now there's a direct financial benefit to accurate record-keeping.
Watch for Updated W-2 Forms: Beginning with tax year 2026, employers are required to separately report qualified tip income and overtime compensation on Form W-2 in new dedicated boxes. For 2025 returns, however, this separate breakdown isn't required, and the IRS is providing penalty relief for employers who can't yet provide it.
Understand the Sunset: The tip and overtime deductions are scheduled to expire after the 2028 tax year. Congress would need to act to extend them beyond that point.
The Broader Impact on Service Industry Workers
The practical effect of this provision varies significantly based on income level. A server at a high-end restaurant in a major city earning $60,000 in wages plus $40,000 in tips would only be able to deduct $25,000 of those tips—but that's still a potential federal tax savings of $5,500 to $6,000 for someone in the 22% bracket.
For workers closer to the median—earning perhaps $30,000 in wages and $15,000 in tips—the entire tip amount would be deductible, potentially saving $1,800 in federal taxes at the 12% bracket.
Looking Ahead
The no tax on tips provision represents a significant shift in how the federal tax code treats service industry compensation. While critics argue it primarily benefits higher-earning workers in tipped professions and could incentivize more businesses to shift toward tipping models, supporters counter that it provides meaningful relief to millions of Americans who've long borne a heavy tax burden on income that can be unpredictable and seasonal.
As you prepare your 2025 returns this spring—or plan for maximizing benefits in 2026 and beyond—consult with a tax professional to ensure you're claiming every dollar you're entitled to under this new provision.
