Yay! No tax on tips! (Well, sort of…)
My wife and all three of my kids have worked as servers in restaurants. It’s hard work, and I’m glad to see that the 2025 tax bill reduced taxes on tips.
Individuals need to understand that taxes on tips were reduced, not eliminated.
For starters, let’s talk about different types of taxes.
Type of taxes
When the media reports that “taxes have been reduced”, they almost never say what type of tax. Here are some major tax categories:
Income tax: Wages, interest, capital gains, and other sources of income are subject to income tax. You may pay both federal and state income taxes.
FICA tax: The Federal Insurance Contributions Act (FICA) tax is a payroll tax that is deducted from your paycheck. Workers and employers both pay FICA tax, and the dollars fund the Social Security and Medicare programs.
Estate tax: If you pass away and the value of your estate is large enough, your heirs may have to file and pay the estate tax on the value of your estate.
According to the Wall Street Journal, 2.5% of all US workers (four million people) earn tips. Taxpayers do not have to pay income tax on some (but not all) tip earnings in 2025.
Who Qualifies?
NBC reports that: “eligible workers are those who already regularly received tips before December 2024.” In addition to restaurant servers: “barbers, hairdressers, nail technicians, and delivery drivers are also expected to be included.”
The specifics are not nailed down as of this writing.
Meet Julie
Julie is a server in a high-end New York restaurant, and she earns $200 a day in tips. Assume that Julie works 240 days as a server in 2025 and earns $48,000 in tips.
The 2025 tax law allows Julie to deduct up to $25,000 in tips. Tips earned above $25,000 remain taxable. Here’s the taxable portion of Julie’s tips:
$48,000 total tips - $25,000 deduction = $23,000 taxable tips
In addition, the deduction may be phased out based on your total income. Once a single taxpayer’s total income reaches $150,000 ($300,000 on a joint return), the deduction is phased out. If Julie has other sources of income, she may not get the entire $25,000 tip deduction.
Phasing out deductions based on higher income is becoming more common in the tax code.
FICA Tax
Julie will pay the employee share of FICA tax (discussed above) on the entire $48,000 in tips. The current rates are 6.2% for Social Security and 1.45% for Medicare, or 7.65% total. Julie pays (7.65% X $48,000), or $3,672 in FICA taxes.
Enjoy The Sunset…
Most tax laws do not last forever, and that is true of no tax on (some) tips. The tip deduction will “sunset” (be eliminated) after 2028.
Why does Congress sunset tax provisions?
Tax cuts reduce revenue and increase the annual deficit in the federal budget. If the tax cut is permanent, revenue projections are lowered permanently, and the annual deficit is even larger.
Solution?
Limit the revenue decrease in future years by sunsetting tax laws.
Of course, once taxpayers get used to a tax deduction, they may be angry when the tax deduction is removed. Politicians often extend tax cuts so constituents don’t get angry (and vote for someone else).
The Tax Cuts and Jobs Act (TCJA) was passed in 2017, and many of the tax cut provisions were scheduled to end in 2025. The 2025 tax bill extended many of the TCJA tax provisions beyond 2025.
The good news is that the no tax on (some) tips deduction applies to all 2025 income. My advice? Work with a tax professional, keep good records, and understand that your tax deduction for tips may be reduced or eliminated down the road.