Challenges with Tip Income Deduction, Particularly for 2025

I've blogged already on the inequities of the tip income deduction (9/10/25 post).  It also has some recordkeeping and compliance challenges for employers and employees, and payors and contractors. These challenges will be greater for 2025 because tipped workers won't have their qualified tips separately reported on their W-2, or 1099-NEC or 1099-K. That won't happen until 2026.

Recently, the IRS provided relief to employers and 1099 filers for 2025 because otherwise they could face penalties for not reporting the qualified tips. The IRS does encourage employers and others to find some way to get information to employees on their qualified tip amount and occupation code, such as via a written statement or online portal (see IR-2025-110 and Notice 2025-62).

Now you might think, don't tipped workers know how much their tip income is?  Well, they might, but do they know what their "qualified" tip amount was?  They are not the same thing!

For example, the following are tips, but not qualified tips that will generate a deduction for the worker.

• Tip received by a waiter at a restaurant but it was automatically added to the bill such as because it was a party of 6. This is not voluntarily paid so is not a qualified tip, even if the restaurant gave it to the waiter.
• The employee works for an employer who is a "specified service trade or business" (SSTB), such as theater or other performing arts business. This might also be confusing for employees with multiple jobs. For example, the bartender employee at the restaurant gets qualified tips (if paid voluntarily), but when she works at the performing arts center as an employee, those tips are not qualified.
• The worker might not be in one of the many listed occupations per a table in the proposed regulations (§1.224-1 at REG–11003225 (9/22/25)). The IRS says it will have the lists at this website, but it is not operational at 11/15/25 - https://www.irs.gov/TippedOccupations. 
• The tipped worker is an independent contractor such as a gardener without a 1099. Their tips are only qualified if they are reported on a Form 1099-NEC or 1099-MISC or 1099-K. If the gardener works for households and gets paid in cash, they won't get a 1099.  If they do work for businesses, they will get a 1099-NEC for 2025 if paid $600 or more. I'm assuming the contractor reports all income including the tips.  As soon as they can, contractors who don't get a 1099, such as because paid in cash by households, they should start taking credit or debit card or PayPal or Venmo so they will get a 1099-K.  We still don't know how PayPal and Venmo will get the tip info, likely they will be required to have the payor specify these amounts.

There is a lot of work here, particularly for the issuers of the W-2 and 1099s.  For example, one example in the proposed regulations is a restaurant where the point of sale machine only offers 3 options on tips:15%, 18% and 20%.  Since there is not an option to put in your own number including zero, this is not voluntary. BUT, since 15% is the minimum in this scenario, if someone tips 18% or 20%, that differential is a qualified tip!  Of course, the restaurant or other establishment with this fact pattern will need to have its recordkeeping system set up to capture this.

Payors will definitely want to get recordkeeping systems ready very soon to be ready to report qualified tips on reporting forms. They might also want to see about changing customer billing arrangements to ease compliance, by, for example, making all tip amounts voluntary.

What do you think?

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 with similar income levels 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? Note that both of these employees do pay employment taxes on the same amount of earned income - $60,000.

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 or is a theater company, appears to be an SSTB making these employees ineligible for the tip income deduction (see Reg. 1.199A-5 for more on SSTB). Seems unfair since regardless of the employer, they are in a tipped profession.  Overall, the tax law would be more equitable to remove SSTB from §199A where it also creates inequities for some businesses that are SSTBs.

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 seek its repeal with any income tax break instead tied to providing it 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.

What Happened to the House OBBBA Provision on P.L. 86-272?

Over the years there have been various proposals to modify P.L. 86-272 enacted in 1959, to address income tax nexus for companies that only sell tangible personal property. Proposals usually call for expanding the application of this rule beyond sellers of tangible personal property and perhaps to taxes other than income taxes. See, for example, H.R. 3063, Business Activity Tax Simplification Act of 2019 (116th Congress).

The key premise of P.L. 86-272 is that a state may not impose income tax obligations on a company selling tangible personal property if the only activity in the state is solicitation of orders that are approved and shipped from outside of the state. The public law doesn't define solicitation of orders.

There was recent activity, including a provision in the House passed version of the OBBBA, to modify P.L 86-272. But it was not included in the Senate version of the bill or the final bill.  Will it return in another tax bill or standalone legislation? Perhaps.

H.R. 427 in the 119th Congress includes this House OBBBA provision. The change involves adding a definition of "solicitation of orders" that is broader than defined by the U.S. Supreme Court since 1992 when the decided Wisconsin Dep't of Revenue v William Wrigley, Jr., Co., 505 US 214. Here is the additional term proposed to be added to P.L. 86-272:

Likely the proposal ties to a new interpretation of P.L. 86-272 by the Multistate Tax Commission in 2021 to consider our digital era that did not exist when this law was enacted in 1959. It might also be aiming to provide greater clarify per recent court cases such as Uline, Inc. v. CIR Minnesota, No. 9435-R (Tax Court, 6/23/23). In this case, sales reps prepared some sales notes and market news notes and helped with a few product returns. This market research was found to be beyond mere solicitation of orders. There were some other activities going on including job fairs in MN.

Query: Why was this multistate provision in the House OBBBA bill but not in the Senate or final bill? Possibly it was dropped since it doesn't directly involve federal revenues so did not meet the requirements for a budget reconciliation bill.

Should this change make its way into another federal bill this year?

What do you think?

OBBB H.R. 1 - Some Track Changes and Commentary

I find it helpful in understanding changes to Code sections to use track changes to readily see what was removed and what was added. And when the text of the public law says something like replace "(B)(ii)" at paragraph (d)(1), it is difficult to picture that in your head and you might make a mistake in figuring out what the change does.

I've done this with past public laws such as the TCJA and IRA 2022.

Here are a few for the OBBBA:

Section 36B with various changes to the Premium Tax Credit but not the one many folks were hoping for to make permanent the removal of the requirement for a PTC that household income cannot exceed 400% of the Federal Poverty Line.  Perhaps Congress will do this before 2026. Otherwise, many people will see their health insurance costs increase and many will drop their insurance.  With fewer in the insurance pool, costs for everyone is likely to go up.  Why did Congress put this limit in the PTC to start with? After all, about 60% of employees get a great tax break by being able to exclude the health insurance premiums their employer pays and there is no requirement for this exclusion that one's income has to be below 400% FPL (which is about $62K for a single person). Also, even individuals eligible for the PTC might not get it if based on their age and zip code and the §36B affordability factors, they may be found to be able to afford a second lowest cost silver plan. Again, harsh since there is no affordability factor for the exclusion for employer-provided health insurance.

Section 45S with changes to the employer credit for paid family and medical leave to expand coverage and make the provision permanent (was set to expire at the end of 2025).

Section 68 with the new limitation for itemizers in the 37% top bracket starting in 2026. There have been proposals in the past for further cut back such as to provide that the savings from itemized deductions can't be more than 25% or 28%. This cut back to 35% is not much.

Section 163(h) with change to the mortgage interest deduction and new temporary interest on domestic car loans. It is odd that they put the car loan at Section 163(h)(4) thereby splitting the mortgage interest rules that are at 163(h)(3) and (5).  I already posted comments on the car loan provision that likely won't get a lot of use for the target group based on income and given the tremendous difference in price between new and used cars and domestic versus foreign, and the small tax savings from the interest deduction.

Section 163(j) with return to calculating the interest expense limitation threshold by adding back to taxable income, depreciation, amortization and depreciation effective for tyba 12/31/24; and some other changes effective for tyba 12/31/25.

Section 170 on charitable contribution deduction with a few OBBB provisions making changes.

Section 199A on the qualified business income (QBI) deduction with key change being making it permanent at the same 20% rate (House proposal for a 23% deduction is NOT in final legislation). A minimum $400 deduction if QBI from active business of at least $1,000, starting after 2025. A few modifications due to §68 limitation on overall itemized deductions.

Section 460(e) with changes to reduce the number of dwelling units per dwelling for home versus residential contracts.

Section 461(l) on excess business loss of noncorporate taxpayers is made permanent (it was already in the law through 2028). Minor modifications on inflation adjustment.

Section 1202 on gain exclusion for noncorporate holders of qualified small business stock. The holding periods, maximum gain exclusion and size of the C corporation are changed.

Hope these are helpful.