Details on IRS prop. regs. on tip income deduction

The IRS on Friday issued proposed regulations (REG-110032-25) on the new deduction for tip income contained in the sweeping tax legislation passed over the summer. The rules contain details on allowable payment forms and include a requirement that the tips be voluntary to be deductible.

In a call with reporters Thursday, Treasury officials said more guidance is forthcoming, especially on which occupations qualify for the deduction under the terms of H.R. 1, P.L. 119-21, commonly known as the One Big Beautiful Bill Act. The law excludes some occupations identified as specified service trades or businesses (SSTBs), such as performing arts or athletics, from the deduction.

The proposed regulations include a list of 68 tipped occupations, which repeat those on a preliminary list from Treasury earlier this month.

Employees who qualify for the deduction must continue to pay Medicare and Social Security payroll taxes on their tip income, Treasury officials said.

To claim the deduction, a worker must be in an occupation on the list and receive qualified tips. The proposed regulations provide a definition of qualified and not qualified tips which, according to an IRS news release, includes the following factors:

• Qualified tips must be paid in cash or an equivalent medium, such as check, credit card, debit card, gift card, tangible or intangible tokens that are readily exchangeable for a fixed amount in cash, or another form of electronic settlement or mobile payment application (excluding most digital assets) denominated in cash.
• Qualified tips must be received from customers or, in the case of an employee, through a mandatory or voluntary tip-sharing arrangement, such as a tip pool.
• Qualified tips must be paid voluntarily by the customer and not be subject to negotiation. Qualified tips do not include some service charges. For instance, in the case of a restaurant that imposes an automatic 18% service charge for large parties and distributes that amount to waiters, bussers, and kitchen staff, if the charge is added with no option for the customer to disregard or modify it, the amounts distributed to the workers from it are not qualified tips.
• Any amount received for illegal activity, prostitution services, or pornographic activity is not a qualified tip.

The proposed regulations note, however, that qualified tips may include those received for a legal service while working for a business that violates the law in other respects.

Determining which occupations qualify for the deduction and which occupations are SSTBs is one of the more confusing sections of the law, Treasury said in the call Thursday. For example, even if an employee receives a tip for services on the list of qualifying occupations, the tip is not deductible if the employer is an SSTB, Treasury said.

The tax break, which applies for tax years 2025 through 2028, allows for a deduction of up to $25,000 for qualified tips per return, meaning the cap applies to a taxpayer filing an individual return or to a married couple filing jointly. The deduction begins to phase out when the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return).

The provision affects a small percentage of U.S. workers, according to the Budget Lab at Yale, which estimated that about 4 million people held tipped occupations in 2023, or about 2.5% of all employment.

Earlier this month, the IRS released a draft of Schedule 1-A (Form 1040), Additional Deductions, which includes sections for calculating four deductions allowed under H.R. 1, including tip income. And in August, the IRS released a draft version of Form W-2, Wage and Tax Statement, for 2026 for qualified tips and a provision for deductible overtime pay under H.R. 1.

Treasury reiterated Thursday that it will provide transition guidance for tax year 2025 for both employees and employers, including guidance on how to handle a situation where nontip and tip income are not stated separately, a Treasury official said.

The comment deadline for the proposed regulations is Oct. 23, and comments can be made through Regulations.gov.

— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.