Inequities of tip income deduction + tip for contractors providing services to non-business customers

The OBBBA (P.L. 119-21; 7/4/25) adds a new deduction of up to $25,000 for qualified tip income. I blogged on this idea before the text of the OBBBA proposal existed, noting several oddities of the deduction (2/23/25 post). Less than 3% of employees earn tip income (the Budget Lab at Yale estimates it is about 2.5% of employees and I cannot find an estimate of the number of contractors who get tips, but it likely is a higher percentage, but still a minority of contractors).

Why should these workers get a tax break that others don't get? Assume two employees each have wage income of $60,000 but for one worker, that figure incudes $10,000 of tip income. That employee will only have to include $50,000 in their taxable income and the non-tipped employee must include the entire $60,000 in their taxable income.  It might even be that the non-tipped employee worked more hours than the other employee. What is the rationale for this? Why not increase the standard deduction or the EITC or add a new bracket below the 10% bracket?

Unlike some other tip tax break proposals, the OBBBA tip income deduction also applies to contractors with qualified tips. But an oddity in the law creates inequities for contractors because a qualification for a tip deduction is, per IRC §224, that the tip income be "included on statements furnished to the individual pursuant to section 6041(d)(3), 6041A(e)(3), 6050W(f)(2) or 6051(a)(18) or reported by the taxpayer [employee] on Form 4137 (or successor)."

OBBBA amends the above reporting rules to require the issuer to note any tip amount. For example, §6050W on issuance of Form 1099-K was amended to require issuers to make a separate reporting of the portion of reportable payments that "have been reasonably designated by payors as cash tips and the occupation" of the recipient. Thus, Congress only allows contractors to get a tip income deduction (assuming all other requirements are met) if they are reported on a 1099-NEC, 1099-MISC or 1099-K.

Contractors who provide services to non-businesses, such as to households, do not get a 1099-NEC. For example, consider two gardeners each earning $70,000 including tips who accept payment only by cash or check. The one gardener provides services to businesses each of which receives $600 or more in services in 2025 ($2,000 in later years), so will get Forms 1099-NEC on which the payors will be required to show the cash tip amount. In contrast, the gardener providing the same value of services to households with the same portion of tip income, will not have any Forms 1099-NEC so will not be able to claim a tip income deduction.

This is illustrated on draft Schedule 1-A, Part II, which only has lines for reporting tip income reported on the forms noted above.

But, there is a possible solution for contractors who provide tipped services to non-business clients. Have clients pay by credit or debit card, or use a third party settlement organization such as PayPal or Venmo and be sure you have over 200 payments totaling over $20,000 for the year to be sure the TPSO has to issue you a 1099-K.  Guidance is not yet out, but I assume when it is, the TPSOs will ask payors how much, if any, of the amount transferred to someone for services is tip income and the occupation of the service provider. I assume that debit and credit card processors will have to start separately reporting the tip amount from charge receipts.

Was the required reporting on W-2, 1099-NEC, 1099-MISC or 1099-K purposeful by Congress to better ensure proper reporting of the tip income amount and the ability for the taxpayer, tax preparer and IRS to verify it? Perhaps, but it seems a bit harsh for contractors serving non-business clients when they are already required to keep proper records under §6001 and regulations.

AND, don't forget that §224 has a restriction that a worker receiving tips in a business that is a specified service trade or business (SSTB) under §199A(d)(2) cannot claim the tip income deduction.  An SSTB is a business in the field of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees, or which involves performance of services that consist of investing and investment management, trading, or dealing in securities (§475(c)(2)), partnership interests, or commodities.

This is also an oddity and unfair.  For example, a dancer, singer or magician employed by a casino or restaurant is eligible for the tip income deduction (assuming all requirements are met) because restaurants and casinos are not SSTBs. However, a dancer, singer or magician working for a company that provider entertainers for parties, appears to be an SSTB so these employees are not eligible for the tip income deduction (see Reg. 1.199A-5 for more on SSTB). Seems inequitable.  Overall, the tax law would be more equitable to remove SSTB from §199A where it also creates inequities.

Well, the tip income deduction will only be around for four years, unless extended. Hopefully the roughly 90% of workers who don't get this tax break even though they have earned income equal to or less than tipped workers, will demand its repeal with any income tax break tied to providing a break to low to middle income workers based on income rather than occupation and who they work for.

What do you think?

OBBBA Includes 2 Marriage Penalties, 1 Neutral, and 1 Marriage Bonus

A marriage penalty exists in the tax system where, all things being the same, the taxes of two single individuals goes up when they get married. A marriage bonus occurs when combined tax liability goes down when two single people marry. And some provisions result in no change. Generally a couple will face a combination of marriage penalty and status quo provisions, but rarely a bonus provision - except under a new temporary OBBBA deduction but likely less than 15% of workers qualify for it (see below). In my examples, I'm assuming the individuals have identical tax situations and consider what happens if they marry. Thus, I'm looking at marriage penalty and bonus built into the tax law rather than built into facts, such as where a low-income individual marries a higher income individuals causing the higher income individual to drop to a lower tax bracket.

Examples of marriage penalty rules including two OBBBA items:

• Where the top 37% income tax bracket starts. At the brackets below this, the MFJ amounts are double the single rates. But at 37% - a rate that applies to less than 1% of individuals, the 37% rate starts at taxable income of $751,601 for MFJ and $626,351.
• The net investment income tax (NIIT) threshold for married is $250,000 and $200,000 for single.
• The maximum mortgage amount for an interest deduction is $750,000 if MFJ or single ($375,000 if MFS).
• The state and local income tax (SALT) cap which for 2018 through 2024 was $10,000 for both MFJ and single ($5,000 for MFS). This penalty remains after OBBBA but at a higher cap of $40,000 for 2025, subject to a phasedown starting at modified AGI of $500,001.
• OBBBA tip income deduction is $25,000 max whether married or single (generally $0 if MFS).
• OBBBA car loan interest deduction is $10,000 whether married or single (however most people won't have even close to $10,000 of interest expense which equates to a loan of about $160,000).

Examples of provisions with no change for marital status (including one OBBBA item):

• Individual tax rates and brackets at the 10, 12, 22, 24, 32 and 35% levels.
• The standard deduction for MFJ is double the single deduction.
• The gain exclusion for selling your principal residence is $250,000 if single and $500,000 if MFJ.
• OBBBA senior deduction is $6,000 per eligible senior (but $0 if MFS).

Examples of provisions with a bonus (I'm just aware of one and it is from OBBBA):

• OBBBA overtime income deduction - $12,500 if single, $25,000 if MFJ (generally $0 if MFS). This new deduction (Section 225) is not $12,500 per spouse. So, assuming that the married couple is below the phaseout level, if one spouse has overtime of $25,000 and the other has none, they get a $25,000 overtime income deduction. If that worker with the $25,000 overtime was instead single, they would only get a deduction of $12,500.

I can't think of other marriage bonus situations in the tax law.  If you know of others, please post them in the comments - thank you!

So, why was the OBBBA deduction for overtime income written differently for married couples than the tip income deduction? Drafting error? Purposeful?

What do you think?  Also see my chart below for a summary of four new OBBBA rules and relevance of marital status.