What Tip-Earning Taxpayers Need to Know under the Tips Deduction Final Regulations

Article Highlights:

Below-the-Line Defined
Who Is Eligible
The $25,000 Annual Cap
MAGI-Based Phaseout
Qualified Tips
Occupation Codes (TTOCs)
Reporting Requirements
Self‑employed Taxpayers
Nonemployee Payees and Payer Responsibilities
SSTB Special Relief
Sample Calculations

A new, temporary federal tax break for tip earners went into law for tax years beginning in 2025 and runs through 2028. The change creates a below-the-line deduction for "qualified tips," but it comes with a number of eligibility rules, reporting requirements, and limits taxpayers need to know.

What "Below‑the‑Line" Means

This tax term describes a tax benefit that reduces taxable income (and thus tax liability) but does not reduce adjusted gross income (AGI). It's available in addition to the standard deduction or itemized deductions.

Who Is Eligible

To claim the tips deduction a taxpayer must:

Be in an occupation that "customarily and regularly" received tips as of December 31, 2024 (the IRS has published Treasury Tipped Occupation Codes, or TTOCs).
Receive "qualified tips" that meet the definition.
For married taxpayers, file a joint return to claim the deduction.
Have a valid work‑eligible Social Security number (SSN).

The $25,000 Annual Cap

Even if you qualify, the deduction is limited. The maximum annual deduction is $25,000 (the cap is the same regardless of filing status).

Modified AGI (MAGI) Based Phaseout

The deduction is reduced by $100 for each $1,000 (or fraction thereof) that your modified adjusted gross income (MAGI) exceeds $150,000 for single filers (or $300,000 for joint filers).

Qualified Tips

What counts as "qualified tips" are cash tips received in occupations that customarily and regularly received tips as of December 31, 2024.

What's included:

Cash tips include traditional cash, but also tips paid by electronic payments, checks, debit and credit cards, gift cards, casino chips, foreign currency, and other tangible or intangible tokens.
Tips from tip pools qualify if they are voluntary, reported, and meet the other requirements.

What's excluded:

Digital assets (such as bitcoin or stablecoins) are excluded.
Mandatory service charges or auto‑gratuities are treated as wages and are not qualified tips.
Tips paid by a customer to an owner‑employee or to someone who has a significant ownership interest in the business (generally 5% or more) are not qualified tips.
Tips earned in activities that are illegal under federal law are ineligible.
Tips attributable to work performed in specified service trades or businesses (SSTBs) generally do not qualify.

Occupation Codes (TTOCs)

The IRS created Treasury Tipped Occupation Codes (TTOCs) to identify eligible occupations. Employers will include the employee's TTOC on the W‑2 (Box 14b beginning in 2026) and report tip amounts in W‑2 Box 12 using code TP.

Reporting Requirements

Beginning in 2026, only tip amounts that appear on the information statements payers must furnish to payees (W‑2s, 1099‑NEC, 1099‑MISC, or 1099‑K) will be eligible for the deduction. 2025 is a transition year with special relief where employers and payers were not required to update forms.

Self‑employed Taxpayers

Self‑employed taxpayers in eligible tipped occupations may take the tip deduction, but:

The deduction is limited to the lesser of $25,000 or the net income from the business that produced the tips.
The tip deduction is claimed on Form 1040 Schedule 1‑A (not on Schedule C), and it cannot be used to create or increase a business loss.

Sample Calculations

Annual Cap Example: If you work as a bartender and receive $40,000 of qualified tips in 2026, your maximum allowable deduction is $25,000 (the statutory cap).
Phaseout Example: A single filer with MAGI of $160,500 faces a phaseout. Their MAGI exceeds $150,000 by $10,500. For each $1,000 (or fraction thereof), the deduction is reduced by $100, so the deduction would be reduced by $1,100 (11 × $100), leaving a maximum deduction of $23,900.