Tip Income and the New 2025–2028 Federal Tip Deduction

For 2025 tax returns, tip income rules largely remain the same — tips are still taxable and must be reported.
However, a new temporary law allows a separate federal income-tax deduction for certain tip income for 2025–2028.

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1. What did NOT change

• All tips (cash, credit-card, pooled) are still taxable income
• Tips are still subject to Social Security and Medicare tax
• Unreported tips still require Form 4137
• Self-employed workers still pay self-employment tax

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2. What DID change for 2025–2028

A new qualified tip income deduction is available:

• Maximum deduction: $25,000 per year
• Available for employees and self-employed workers
• Subject to MAGI phase-out limits
• Not available to married filing separately
• Does NOT reduce payroll or self-employment tax

This is an income-tax deduction, not an exclusion from wages.

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3. Where the tip deduction is claimed (important correction)

For 2025, the IRS places the tip deduction on:

• Form 1040
• Schedule 1-A – Additional Deductions
• Line designated for Qualified Tip Income Deduction (2025–2028)

Key point:

• Wages and tips are fully included in income first
• The deduction is taken after income is reported, through Schedule 1-A

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4. Updated real-life examples (with correct forms)

Example 1: Mina — server who reported all tips

Facts

• $15,000 base wages
• $25,000 tips
• All tips reported monthly to employer
• W-2 correctly reflects all tips

Forms used

• Form W-2 → wages including tips
• Form 1040 → wages included in income
• Schedule 1-A (Form 1040) → claims Qualified Tip Income Deduction (up to $25,000)

What she does NOT need

• No Form 4137 (all tips reported timely)

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Example 2: Daniel — bartender with unreported cash tips

Facts

• W-2 includes reported wages and card tips
• $5,000 cash tips not reported to employer

Forms used

• Form 4137
  • Reports unreported tips
  • Calculates additional Social Security and Medicare tax
• Form 1040
  • Includes $5,000 in income
• Schedule 1-A (Form 1040)
  • Claims Qualified Tip Income Deduction (if eligible)

Result
Daniel pays extra payroll tax via Form 4137, but may still deduct the $5,000 as qualified tips on Schedule 1-A, subject to limits.

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Example 3: Lina — self-employed hair stylist

Facts

• Reports $30,000 gross receipts on Schedule C
• $10,000 of that amount is tip income

Forms used

• Schedule C → reports all income
• Schedule SE → calculates self-employment tax
• Form 1040 → includes net profit
• Schedule 1-A (Form 1040) → claims Qualified Tip Income Deduction (up to $10,000)

What she does NOT use

• No Form 4137 (not an employee)

Result
Lina still pays SE tax on tip income, but the deduction on Schedule 1-A reduces her taxable income.

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Example 4: Marco — server with allocated tips (W-2 Box 8)

Facts

• W-2 Box 8 shows $3,000 allocated tips

Forms used

• Form 4137
  • Reports allocated tips
  • Calculates payroll tax
• Form 1040
  • Includes allocated tips in income
• Schedule 1-A (Form 1040)
  • Claims Qualified Tip Income Deduction (if eligible)

Result
Marco pays payroll tax on allocated tips but may reduce taxable income using the new deduction on Schedule 1-A.

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5. Key reminders for 2025

• The tip deduction is not automatic
• It does not reduce Social Security or Medicare tax
• Tips must still be:
  • Reported to the employer (employees)
  • Included in gross income
• The deduction is claimed only on Schedule 1-A