How will state income taxes treat reported tips if the federal law changes?

Even if the “No Tax on Tips” Act becomes federal law, most states will continue to tax tip income unless they pass similar legislation. Workers should check with their state’s tax agency to see if any changes are being considered or enacted at the state level.

Will this deduction apply to undocumented workers who earn tips?

No. To claim any deduction on a federal tax return, including this one, you must file using a valid Social Security Number or Individual Taxpayer Identification Number (ITIN). The law is intended for workers who report tips to employers and file legal federal tax returns.

Do cash-only businesses have to do anything differently under this bill?

No changes are required for how cash-only businesses operate. However, they may see increased pressure to maintain accurate tip reporting systems, since more employees may now want to officially report tips to benefit from the deduction.

Could the deduction be claimed retroactively for tips earned before 2025?

No. The bill is structured to take effect starting with the 2025 tax year. That means only tips earned on or after January 1st, 2025, would be eligible for the deduction—assuming the bill becomes law.

Can this deduction be combined with other work-related deductions?

Yes. Because it's an above-the-line deduction, it doesn’t interfere with other itemized or standard deductions. You can still claim other deductions you qualify for, such as unreimbursed expenses or educator expenses, depending on your situation.

No Tax on Tips: What the New Bill Could Mean for Your Taxes

Last updated July 2, 2025

Millions of service industry workers in the U.S. rely on tips for a significant part of their income. This includes bartenders, waitstaff, hairstylists, and hotel attendants. But until now, the IRS has treated those tips just like wages for federal income tax purposes. That could soon change.

In early 2025, the U.S. Senate unanimously passed a groundbreaking piece of legislation known as the “No Tax on Tips Act” (S.129). If signed into law, the bill lets workers deduct up to $25,000 in reported tips from income. This could significantly reduce taxes for those who depend on gratuities.

The bill still needs to pass the House of Representatives before becoming law. Even so, it’s already generating buzz among workers, employers, and tax professionals. What does this mean for your paycheck? How will it affect the tax forms you receive—or the ones you file?

This blog explains what the bill says and who it affects. It also covers how it could change your tax forms. If you work in service or beauty, here’s how your taxes might change in 2025.

What is the “No Tax on Tips” Act?

Lawmakers introduced the “No Tax on Tips Act” to provide tax relief for workers who earn income from tips. It helps those who earn much of their income from customer tips. Senator Ted Cruz introduced the bill, and a bipartisan group of lawmakers backed it. The bill passed the Senate in May 2025 with unanimous support—an increasingly rare feat in Washington.

The goal of the bill is simple: exclude up to $25,000 in cash tips from federal income tax each year. But the exclusion applies only to qualified, reported tips. Workers report these tips to employers, who then include them on tax forms like the W2.

Who Qualifies?

To benefit from the deduction:

You must receive tips in cash (credit card tips likely count too, as long as you report them).
You must report those tips to your employer.
You must work in an occupation where tipping was customary as of December 31, 2023.
Your total annual compensation must not exceed $160,000 to claim the deduction.

This proposed deduction would be “above the line” on your tax return. You don’t need to itemize to benefit. It would reduce your adjusted gross income (AGI). A lower AGI could help you qualify for credits like the Child Tax Credit or Premium Tax Credit.

Status of the Bill –

As of July 2025:

The Senate has passed the bill.
The House of Representatives must still approve it.
If it becomes law, the change would take effect for tax year 2025, so you’d first see its impact when filing in 2026.

Who Does the Bill Affect?

Restaurant servers affected by No Tax on Tips

The “No Tax on Tips” Act directly targets tipped workers—people who rely heavily on customer gratuities for income. This includes a wide range of roles in the hospitality, food service, and personal care industries. If tips make up a meaningful portion of your income and you report them to your employer, this bill could have a direct impact on your taxes.

Professions Likely to Benefit –

Here’s a snapshot of the types of workers who could qualify:

Restaurant servers and bartenders
Hotel staff, such as bellhops and room attendants
Rideshare and delivery drivers
Casino dealers and gaming service workers
Hair stylists, barbers, nail techs, and estheticians
Massage therapists and spa workers
Valets and parking attendants

Basically, if tipping is customary in your job and you report your tips, this bill directly supports you. One important caveat: the tax deduction applies only if your total annual compensation (including tips, wages, and bonuses) is $160,000 or less in the prior tax year. This income cap helps ensure the benefit targets middle- and lower-income workers who rely on tips as core income, not supplemental earnings.

Tip Reporting is Essential –

To take advantage of the proposed deduction:

You must accurately report tips to your employer.
Under current law, the IRS taxes these reported tips and employers include them on Form W2.
With this bill, those same reported tips could now reduce your taxable income—a strong incentive to report tips honestly and consistently.

Failing to report tips still carries penalties and could disqualify you from receiving the benefit. So while the bill lightens the tax burden, it also reinforces the importance of staying compliant with IRS reporting rules.

What This Means for Your Tax Forms

If the “No Tax on Tips” Act becomes law, it won’t change how your employer reports your income, but it will change how you report and deduct tip income when filing your personal taxes. Knowing which tax forms you need will help you prepare and file accurately.

Form W-2: Employer Reporting

Your employer will still issue a W2, which reports all of your wages—including tips. Here’s how tips typically appear:

Box 1 – Wages, tips, and other compensation: This includes all reported tips.
Box 7 – Social Security tips: This box shows tips subject to Social Security tax.

The new bill does not change what goes on your W-2. Employers must still include reported tips, and you must continue to pay Social Security and Medicare (FICA) taxes on them.

However, under the new bill, you’ll be able to subtract up to $25,000 in reported tips from your taxable income on your own tax return—effectively reducing how much income tax you owe.

Form 1040: Where You Claim the Deduction

Your individual tax return, Form 1040, is where the magic happens.

The deduction for reported tips would be an “above-the-line” deduction, which means:
- You don’t need to itemize deductions to benefit.
- It reduces your adjusted gross income (AGI) directly.
- A lower AGI could also make you eligible for other credits and benefits.

While the IRS hasn’t released updated instructions on how to enter this deduction, it will likely list it under “Adjustments to Income”—possibly with a dedicated worksheet or validation schedule.

Form 4137: For Unreported Tips

If you didn’t report all your tips to your employer, you still need to report them using Form 4137, “Social Security and Medicare Tax on Unreported Tip Income.” This form helps you pay the correct FICA taxes, even if your employer didn’t withhold them.

*Important: The proposed tip deduction only applies to reported tips, so any tips disclosed late on Form 4137 likely wouldn’t qualify for the income tax break.*

How Could This Affect Your Finances?

If passed into law, the “No Tax on Tips” Act could offer real tax savings for service workers by allowing up to $25,000 in reported tips to be deducted from federal taxable income. For example, a worker earning $40,000 in base wages and $15,000 in tips would currently have a taxable income of $55,000. Under the new legislation, that taxable income could be reduced to $40,000—potentially lowering the worker’s overall tax liability. This reduction could not only push someone into a lower tax bracket but also increase eligibility for income-based credits like the Earned Income Tax Credit (EITC) or the Child Tax Credit (CTC).

In practical terms, a lower taxable income means the taxpayer might owe less to the IRS at filing time—or receive a larger refund if more tax was withheld than necessary throughout the year. This could provide welcome relief during tax season for workers who depend on refunds to catch up on expenses or make planned purchases.

The bill also changes the incentive structure around tip reporting. In the past, some workers may have hesitated to report all of their tips, fearing higher taxes. Now, there’s a clear benefit to being transparent: each dollar of reported tips—up to $25,000—has the potential to reduce what you owe in taxes. This shift could lead to better compliance with IRS rules and more accurate reporting industry-wide.

However, it’s important to note that the bill only addresses federal income tax—not payroll taxes. You’ll still owe Social Security and Medicare taxes (FICA) on all reported tips, and employers will continue withholding and reporting those amounts on your Form W-2. So while your take-home pay might not immediately increase, your year-end tax burden could decrease significantly, improving your financial picture in the long run.

When Does This Take Effect?

As of July 2025, the “No Tax on Tips” Act has passed the U.S. Senate but still needs to be approved by the House of Representatives and signed by the President before it becomes law. If that happens, the new rules would go into effect for tax year 2025. That means workers would start benefiting from the deduction for tips earned in 2025, and they would claim the deduction when they file their 2025 tax return in 2026.

It’s important for tipped workers to be aware of this timeline so they can start planning ahead. If the bill becomes law, reporting your tips accurately in 2025 will be key to taking advantage of the deduction. Since employers will still report your total tip income on Form W-2, the IRS will use that information to validate any deduction you claim on your Form 1040.

Until the bill is finalized, it’s a good idea to stay informed and maintain detailed records of your reported tips. This way, you’ll be ready to take full advantage of the deduction if the law is enacted—and you’ll remain compliant with current IRS rules in the meantime.