A new federal law, part of the “One Big Beautiful Bill” enacted on July 4, introduces a significant tax change for service industry employees. The provision allows certain workers to deduct up to $25,000 of their tipped income from their federal taxable income, but the benefit is temporary and comes with specific income limitations and reporting requirements.
While promoted as a major tax cut for the middle class, the actual financial impact on bartenders, servers, and other tipped professionals will vary. The law is set to take effect for the 2025 tax year, with detailed guidance from the IRS expected later this year.
Key Takeaways
- A new law allows a federal tax deduction of up to $25,000 on tipped income for eligible workers.
- The deduction is temporary, applying only to tax years 2025 through 2028.
- Income limits apply: The benefit phases out for individuals earning over $150,000 and joint filers earning over $300,000.
- Only tips reported to an employer and included on a W-2 form are eligible for the deduction.
- The measure is a deduction, not a complete tax exemption. Payroll taxes for Social Security and Medicare still apply to all tips.
Understanding the New Tip Deduction Law
The new legislation, effective from the 2025 tax year, aims to reduce the federal income tax burden for millions of Americans who earn a substantial portion of their income from tips. The core of the provision is a new tax deduction, not a complete elimination of taxes on gratuities.
Under the law, an employee who “customarily and regularly received tips” as of December 31, 2024, can subtract up to $25,000 in tip income from their total income when calculating their tax liability. This applies to both cash and credit card tips, including those received through tip-sharing arrangements.
However, this tax relief is not permanent. According to the IRS, the provision is scheduled to expire after the 2028 tax year unless extended by future legislation.
Important Clarification: Deduction vs. Exemption
Tax experts emphasize that this new rule creates a deduction, which reduces your taxable income. It is not an exemption, which would make tips completely tax-free. Tipped income is still considered taxable income by the federal government.
Who Qualifies and What Are the Limits?
Eligibility for the full $25,000 deduction is not universal. The law includes several important qualifiers and limitations that workers must understand.
Income Thresholds
The deduction is targeted at middle-income earners. For individual taxpayers, the $25,000 deduction begins to phase out if their modified adjusted gross income (MAGI) exceeds $150,000. For married couples filing jointly, the phase-out starts at a MAGI of $300,000.
Jason Gardner, deputy executive director for the Utah State Tax Commission, explained that for every $1,000 an individual earns above the $150,000 threshold, the available tip deduction is reduced by $100.
Standard Deduction vs. Tip Deduction
The new tip deduction can be claimed in addition to the standard deduction. This means taxpayers do not need to itemize their deductions to benefit from this new provision, making it accessible to a broader range of people.
Reporting is Mandatory
A critical requirement of the law is that all tips must be properly reported to be eligible for the deduction. “A person can only deduct tip income that was reported to the employer and included on the employee’s W-2,” Gardner stated. This means cash tips taken home without being declared to an employer cannot be included in the $25,000 deduction.
This rule reinforces existing tax law that requires all tips to be reported as income. The IRS is expected to publish a formal list of qualifying occupations by October 2, 2024, providing more clarity for workers.
How the Deduction Works in Practice
Andrew Lautz, director of tax policy for the Bipartisan Policy Center, noted the real-world benefit depends on a worker's total income. The deduction is most helpful for those earning more than the standard deduction, which is $15,000 for single taxpayers.
“Getting to carve out up to $25,000 in tipped income from any federal income taxes is a meaningful benefit,” Lautz said. “It’ll be hundreds of dollars to thousands of dollars, depending on who the taxpayer is and what tax bracket they’re in.”
For workers earning less than the standard deduction, the new provision offers no additional benefit, as they typically do not owe federal income tax anyway.
Payroll Taxes Remain Unchanged
It is crucial for employees to understand that this deduction only applies to federal income tax. Tips will still be subject to payroll withholding for Social Security and Medicare taxes. The law does not change how these mandatory contributions are calculated or collected.
The potential impact on state tax returns is also still unclear. In Utah, for example, the State Tax Commission is waiting for the official 2025 IRS forms to determine how the federal deduction will affect state taxable income. Details are expected in December.
Perspectives from Service Industry Workers
To understand the on-the-ground impact, Wealtoro spoke with service professionals in Salt Lake City, who offered mixed reactions to the new law.
A Bartender's View
Sam Miller, a career bartender with 15 years of experience, works at the James Beard-nominated cocktail bar Water Witch. He estimates he earns around $50,000 in tips annually.
“I believe the new law definitely will give us tax benefits,” Miller said, noting it would be most advantageous for full-time workers like himself who are well below the $150,000 income cap. Under the new rule, he would only pay federal income tax on about half of his tipped earnings.
However, he described the potential savings as “bittersweet.” Miller worries that a higher net income could disqualify some workers from essential government programs. “When I was a young bartender, I relied heavily on all of those benefits,” he recalled. “Low-income housing, food stamps, all that was definitely a part of my younger years.”
A Server's Calculation
Derek Emeroy, a lead server at Violet restaurant, earns a tipped minimum wage of $2.13 per hour, with the majority of his income coming from approximately $45,000 in annual tips.
He is skeptical about the scale of the benefit. “People always say, ‘Oh, you don’t have to pay on any of your tips now.’ And I’m like, ‘That’s the way they framed it, but that’s not how it is,’” Emeroy said.
After reviewing his previous tax returns, he calculated that the deduction might only save him a few hundred dollars a year. “If he winds up owing about $400 next tax season instead of $800, that’s only about $400 he’s saved,” he explained.
Emeroy believes a different policy change would be more effective. He argued that increasing the federal tipped minimum wage would be “more beneficial” than the tax deduction. “Even if it’s not up to the $7.25 minimum wage, if they just made it $4, the taxes on tips wouldn’t even affect me at all,” he said, as his hourly wage would then be sufficient to cover his tax obligations.
