Is it possible to deduct qualified tips when calculating taxable income?
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Yes, for tax years 2025 through 2028, individuals may deduct qualified tips when calculating taxable income, subject to certain limitations and requirements.
1. Legal Basis and Deduction Amount
Section 224 of the Internal Revenue Code, as enacted by the One Big Beautiful Bill Act (OBBBA), allows an individual to deduct the amount of "qualified tips" received during the taxable year, up to a maximum of $25,000 per year. This deduction is available for tax years beginning after December 31, 2024, and before January 1, 2029.
2. Definition of Qualified Tips
- "Qualified tips" are defined as cash tips received by an individual in an occupation that customarily and regularly received tips as of December 31, 2024.
- The tips must be paid voluntarily, not subject to negotiation, and determined by the payor (i.e., the customer).
- The deduction does not apply to tips received in a "specified service trade or business" as defined in section 199A(d)(2), unless the individual is an employee and the employer's business is not a specified service trade or business.
- Tips must be reported on the appropriate forms (such as statements furnished to the employer or reported on Form 4137 for unreported tips).
3. Income Phase-Out
- The deduction is reduced by $100 for each $1,000 (or fraction thereof) by which the taxpayer's modified adjusted gross income (MAGI) exceeds $150,000 ($300,000 for joint filers).
- MAGI for this purpose is AGI increased by any amount excluded under sections 911, 931, or 933.
4. Other Requirements
- The taxpayer must include their Social Security number on the return to claim the deduction.
- For married individuals, the deduction is only available if a joint return is filed.
5. Example Calculation
Suppose a single taxpayer receives $30,000 in qualified tips in 2025 and has a MAGI of $170,000:
- Maximum deduction: $25,000 (statutory cap)
- MAGI exceeds $150,000 by $20,000
- Phase-out: $20,000 / $1,000 = 20 increments; 20 × $100 = $2,000 reduction
- Allowable deduction: $25,000 − $2,000 = $23,000
6. Reporting
- The deduction is claimed as an above-the-line deduction, reducing adjusted gross income.
- Tips must be properly reported to the employer or on Form 4137 if unreported.
Summary: For tax years 2025–2028, individuals can deduct up to $25,000 of qualified tips from taxable income, subject to a phase-out for higher incomes and other statutory requirements. This deduction is not available for tax years beginning after December 31, 2028.
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