Ask the Editor, September 26: Tax Questions on the New Tips Deduction

Each week, in our Ask the Editor series, Joy Taylor, The Kiplinger Tax Letter Editor, answers questions on topics submitted by readers. This week, she’s looking at questions on the new tax deduction for tipped income. (Get a free issue of The Kiplinger Tax Letter or subscribe.)

1. What is the tips deduction?

Question: I work as a hairdresser. I heard that my tips will now be tax-free. Can you explain how this works?

Joy Taylor: The “One Big Beautiful Bill” enacted lots of tax breaks, with some important ones beginning this year. One of these is the deduction for up to $25,000 of tipped income. It’s available for taxpayers taking standard deductions and for those who itemize on Schedule A of Form 1040. The deduction is below-the-line, meaning it’s subtracted from adjusted gross income to arrive at taxable income. This deduction is temporary, first taking effect on 2025 tax returns filed next year and ending after 2028.

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There are lots of rules and limitations. For example, there’s an income limit. The deduction begins to phase out at modified adjusted gross income (modified AGI) over $300,000 for joint filers and $150,000 for others. And the taxpayer who received the tips must include a Social Security number on Form 1040.

Only qualified tips are deductible. They must be paid voluntarily without negotiation in an amount chosen by the payer. Tips received through a tip-sharing arrangement are also qualified tips. Service charges or other amounts automatically added to a customer’s bill don’t qualify unless customers can disregard or modify them without consequences. Individuals in certain professional service businesses can’t take the deduction. The tips must generally be reported on IRS Form W-2, 1099 or similar form. Self-employed individuals must include the tips in their Schedule C income.

The tips must be from an occupation that traditionally receives tips. The IRS lists 68 job titles in eight categories that meet this rule. Many of the job titles make common sense. These include bartenders, restaurant wait staff, maids, caterers, casino dealers, parking valets, taxi and rideshare drivers, hairdressers, manicurists, massage therapists, tour guides, chefs, musicians and singers, bellhops, tutors, pet sitters, nannies, golf caddies and tattoo artists. Others aren’t as intuitive, such as digital content creators, home heating and air conditioning mechanics, and home plumbers and electricians.

2. Is the write-off higher for married filers?

Question: I am married and file a joint return with my husband. We both receive tips. Is the $25,000 maximum tips deduction doubled for us?

Joy Taylor: No. The maximum deduction is $25,000, regardless of whether you file a joint return, single return or head-of-household return. Note that if you are married, you must file a joint return with your spouse to claim the tips deduction. Married couples who file separate tax returns cannot take the write-off for tipped income.

3. What is modified AGI?

Question: What is the definition of modified AGI for purposes of the tips deduction?

Joy Taylor: The tips deduction begins to phase out at modified AGI over $300,000 for joint filers and $150,000 for other filers. More specifically, the write-off is reduced, but not below zero, by $100 for each $1,000 by which the taxpayer’s modified AGI exceeds the $300,000 or $150,000 thresholds.

The federal tax law has many different definitions of modified AGI. For this purpose, modified AGI is AGI plus any foreign earned income exclusion, foreign housing exclusion, and certain excluded income because it was received from sources in Puerto Rico, Guam, American Samoa or the Northern Mariana Islands.

4. What does cash tips mean?

Question: I heard that only cash tips are deductible. Is that correct?

Joy Taylor: Yes and no. While the relevant statute defines qualified tips as cash tips received by an individual, the statute and the IRS’s proposed regulations broadly define cash tips. Per the regulations, they include tips paid by cash, check, debit card, credit card, gift card, casino chips that can be readily exchanged for cash, or through an electronic or mobile payment app. Tips received through a tip-sharing arrangement or tip pool also qualify.

5. What about automatic gratuities?

Question: I work as a server at a restaurant, and we add a 20% automatic gratuity to each customer’s check. Can I deduct my share of these gratuities?

Joy Taylor: It depends. Service charges, automatic gratuities or other mandatory amounts automatically added to a customer’s bill aren’t eligible to be deducted as qualified tips unless the customer is expressly provided an option to disregard or modify it without consequences. The IRS’s proposed regulations provide several examples to illustrate this concept.

6. How do I claim the tips deduction?

Question: Where do I report the tips deduction on my Form 1040 or 1040-SR?

Answer: The IRS has released a draft new schedule for eligible taxpayers to claim the tips deduction, as well as the $6,000 senor deduction for filers 65 or older ($12,000 if both filers are age 65 or older), the up-to-$12,500 of overtime pay ($25,000 for joint filers), and the deduction for up to $10,000 of interest paid on loans to buy a new automobile. Eligible taxpayers will use Schedule 1-A titled “Additional Deductions” to calculate the modified AGI and to claim the tax breaks for which they qualify. They will then transfer the total to new line 13-b on the 2025 Form 1040.

About Ask the Editor, Tax Edition

Subscribers of The Kiplinger Tax Letter, The Kiplinger Letter and The Kiplinger Retirement Report can ask Joy questions about tax topics. You'll find full details of how to submit questions in each publication.
Subscribe to The Kiplinger Tax Letter, The Kiplinger Letter or The Kiplinger Retirement Report.

We have already received many questions from readers on topics related to tax changes in the OBBB and more. We will continue to answer these in future Ask the Editor round-ups. So keep those questions coming!

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