Should gratuities be tax-free? That’s the premise behind the “No Tax on Tips” provision of the One Big Beautiful Bill Act (OBBBA). Starting in 2025, tipped workers will be able to deduct up to $25,000 from their taxable income—though not from payroll taxes.
It is an applause line with broad political appeal, especially among workers in tip-heavy industries like hospitality. But, just like the overtime deduction, this isn’t strictly speaking a pure tax cut—it’s a narrowly tailored deduction that chooses winners and losers and comes with a host of administrative headaches.
While it may seem like relief for low-wage workers, under the hood it is quite a bit more complicated.
What No Tax on Tips Does
To start, the “no tax on tips” provision of the OBBBA, Section 70201, isn’t a tax exemption—it’s a deduction. Specifically, it is an above the line deduction of up to $25,000 for tips received in the course of ordinary employment, as long as they are voluntary and properly reported. Like the overtime deduction, this one is also temporary: it applies through tax year 2028.
It is also gated. Tips must be reported on a W-2 or other IRS-recognized form, and the job must be one that customarily receives tips—the Treasury Department will be issuing guidance fleshing out that latter bit. If you work in hospitality, you will probably qualify. If you’re a flyfishing instructor collecting Venmo payments and occasional cash thank-yous, maybe not.
The deduction doesn’t apply to automatic service charges, like those mandatory 20% gratuity tack-ons for large parties. The deduction is also completely unavailable to anyone working in Specified Service Trades or Businesses (SSTB), which is an exclusion category that includes lawyers, financial advisors, and any job where the key asset is skill. Whether employees of SSTBs are also excluded remains an open question.
As with the overtime deduction, this one phases out for higher earners—specifically those with modified adjusted gross income over $150,000 for a single filer or $300,000 for joint filers. The tips also remain subject to payroll taxes, so this isn’t a full tax holiday but is instead a narrow, federally blessed deduction for some earnings stemming from very specific kinds of labor.
Who Benefits From No Tax on Tips?
The political pitch is pretty simple: this is for the hardworking bartender, waiter, or barista trying to make their paycheck stretch over an ever-increasing cost of living. But, as with the overtime deduction, the real story lies in the actual tax math—and who has enough income to fully benefit.
More than 4 million Americans work in tipped occupations, but many of them earn too little to owe federal income tax in the first place. Between the standard deduction and other credits, a huge share of tipped workers—many single parents and part-time employees that could most benefit—already have zero income tax liability. For them, the deduction is a mirage. As a deduction, it does not generate a refundable credit if it brings an employee’s taxable income below $0.
Thus, the real winners are middle-income workers in full-time, tip-heavy jobs who report all their tips by the book. A bartender earning $35,000 in wages and $15,000 in tips might save $2,000 or more per year on their tax bill, assuming proper reporting. But that is a narrow slice of the labor market: not too poor to owe tax, not too rich to phase out, and perfectly tax-compliant.
There is another catch in that, to claim the deduction, both the worker and, if applicable, their spouse must have valid Social Security numbers. That rules out many immigrant workers, particularly those in mixed-status households.
Equity and Distortions
At first glance, “no tax on tips” reads like a gesture of economic respect to service workers. In practice, it is a policy that distorts how compensation is structured and who gets rewarded for what kind of work. In short, it picks winners and losers.
Two workers earning $50,000 a year could face very different tax bills depending on whether some of that income came as tips. And yet, tip income and wage income each spend equally.
This violates basic horizontal equity—the principle that similar taxpayers should shoulder similar tax burdens. As with the overtime deduction, the tips deduction doesn’t say “work matters;” it says how you get paid matters more than what you get paid.
Employers now have a new incentive to lean into tip-based compensation, and lower base wages. This disincentivizes employers from providing stability for their workers and could put more workers at the mercy of customer generosity. Some employers may even reclassify service charges or performance bonuses as “tips”—pushing compliance boundaries in the hope of creating deductible income for workers.
At the same time, workers will face the opposite pressure. The more they can convert income into voluntary tips, the more tax they avoid. That’s not just an incentive for dishonesty; it’s an invitation to creative classification and perhaps a shift in employment. In a gig economy already rife with precarity and underreporting, this could widen the gulf between what workers earn and what they disclose.
While the policy may feel like a reward for hustle, much like its overtime cousin, it quietly erodes the wage floor, complicates enforcement, and pushes a compensation model that depends on customer generosity rather than employer obligation.
Policy Tradeoffs and the Politics That Drive Them
The “no tax on tips” provision may cost less than the overtime deduction—early estimates suggest perhaps as little as just tens of billions of dollars—but it still represents a diversion of public funds. Every dollar spent subsidizing voluntarily-reported tip income is a dollar not spent in service of raising the minimum wage or providing a refundable benefit that can assist the broader service economy.
Instead of lifting wages systemically, Congress is opting to privilege a narrow slice of income for a narrow subset of workers, conditioned on proper paperwork.
Politically, however, it is bulletproof. You don’t lose elections by giving tax breaks to waiters. It polls well, headlines even better, and offers lawmakers an easy applause line to show support for the working class. Most importantly, it asks nothing of employers.
And yet, no one wants to admit what “no tax on tips” really is: a tax code preference for irregular, customer-subsidized income over salary; a subsidy for volatility over stability; and an incentive for gratuities at the expense of guarantees.