Updated for the One Big Beautiful Bill Act (P.L. 119-21, signed July 4, 2025) - Key change: New IRC §224 creates a federal below-the-line deduction for tip income up to $25,000 (2025-2028), claimed on the new Schedule 1-A and flowing to Form 1040 line 13b. NJ Division of Taxation issued official guidance on December 1, 2025 confirming NJ does NOT conform. Reflects the final §224 Treasury regulations (Treas. Reg. §1.224-1) and NJ Treasury OBBBA guidance.

In This Article

  1. The No-Tax-on-Tips Deduction: What It Actually Is
  2. How IRC §224 Works: The Mechanics
  3. Dollar Examples for NJ Workers
  4. The NJ Conformity Problem
  5. Employer Obligations Under the Tip Deduction
  6. Industries Covered - and Industries That May Not Qualify
  7. How to Claim the Deduction on Your Federal Return
  8. Frequently Asked Questions
  9. Ready to File With Confidence?

Disclaimer: This article is educational and does not constitute tax advice or create a CPA-client relationship. Tax laws change frequently. Consult a licensed CPA before filing.

The No-Tax-on-Tips Deduction: What It Actually Is

The phrase 'no tax on tips' is shorthand for a new below-the-line federal deduction created by IRC Section 224 under the One Big Beautiful Bill Act. It does not exempt tip income from tax - tips remain taxable income. Instead, it allows qualifying workers to deduct up to $25,000 in tip income from their federal taxable income (not AGI) via the new Schedule 1-A, which flows to Form 1040 line 13b.

Two distinctions matter. First, the deduction is below-the-line: it reduces taxable income but does NOT reduce AGI. EITC, CTC, IRA deductibility, student loan interest, and other benefits that phase out by AGI or MAGI are unchanged by claiming §224. Second, the federal tax difference depends on the bracket computation. A $22,000 tip deduction at the top of a single filer's 12% bracket produces a $2,640 single-rate illustration; if some of the tips fall in the 22% bracket the arithmetic difference can change. Multiplying the entire deduction by one marginal rate may not match the completed bracket computation. The deduction is also not a dollar-for-dollar credit, and it does not apply to Social Security and Medicare taxes (FICA). A separately accepted tax-preparation scope applies the return rules to client-supplied facts; no full deduction or dollar result is promised.

How IRC §224 Works: The Mechanics

Who qualifies: Employees AND self-employed workers (per the final §224 regulations) in occupations on the IRS-published list. The controlling list is at Treas. Reg. §1.224-1(h) ('List of Occupations that Receive Tips') and maintained online at IRS.gov/TippedOccupations (opens in a new tab). Covered categories include food and beverage service, hotel and hospitality, hair / nail / beauty services (barbers, cosmetologists, estheticians), personal care and body work (massage therapists, spa workers), casino dealers, valets, and similar tip-based occupations. Occupation and Schedule C status are not enough: the payment and information reporting must independently satisfy Section 224.

Maximum deduction: Before the MAGI phaseout, the cap is $25,000 per year. If the full $30,000 consists of qualified tips and all occupation, voluntariness, information-reporting, filing-status, and self-employed net-income rules are satisfied, the deduction is at most $25,000 before the phaseout; the allowable amount can be lower on the actual return.

Tax years: 2025, 2026, 2027, and 2028 only. The deduction is scheduled to sunset on December 31, 2028 unless Congress extends it.

Phase-out: The deduction is reduced once your MAGI (before the tip deduction) exceeds:

  • $150,000 for single filers (fully phased out at $400,000 MAGI - $250K phase-out range at $100 reduction per $1,000 excess MAGI per IRC §224(b)(2)(A))
  • $300,000 for married filing jointly (fully phased out at $550,000 MAGI)

The phase-out reduces the maximum deduction by $100 for every $1,000 of MAGI above the threshold (10% rate per IRC §224(b)(2)(A)). With a $25,000 maximum deduction and a 10% reduction rate, the phase-out range is $250,000. The deduction is fully eliminated at $400,000 MAGI single (starting from $150,000) and $550,000 MAGI MFJ (starting from $300,000). Those $400,000 / $550,000 endpoints assume you are claiming the full $25,000 deduction; if you claim fewer tips, your deduction phases out sooner - for example, $10,000 of qualified tips is fully phased out by $250,000 MAGI (single). Apply the actual MAGI, filing status, and qualified-tip amount.

Reporting paths differ by year: For 2025, employees use W-2 Box 7 together with employer statements and corroborating earnings records under the transition rules; 2025 nonemployees may reconstruct tips only when the cash tips were included in an applicable aggregate Form 1099 box and contemporaneous records identify the amount. For 2026 and later, W-2 Box 12 code TP and the occupation field, or the new separately reported qualified-cash-tip and TTOC fields on Forms 1099-NEC/MISC/K, ordinarily supply the statutory statement. Form 4137 remains an employee-tip path. Schedule C, a daily log, or an aggregate 1099 amount alone does not substitute for the required 2026 statement.

Required eligibility rules (final §224 regulations): Several mechanical rules apply that the statute imposes through Treas. Reg. §1.224-1:

  • SSN required: The taxpayer must have a valid-for-work Social Security Number issued by the return due date, including extensions. ITINs do not qualify.
  • MFJ required if married: Married taxpayers must file jointly. MFS filers are ineligible for §224.
  • SSTB transition: Notice 2025-69 treats a listed tipped occupation as outside an SSTB until January 1 of the first calendar year after final Section 224 SSTB regulations are issued. The April 2026 final qualified-tips regulations reserved that subsection, so the relief remains operative as of July 29, 2026. This transition rule does not classify the trade for the separate Section 199A QBI deduction.
  • Voluntariness: Only voluntary tips qualify. Automatic gratuities, mandatory service charges, and added-on 'service fees' are excluded because they lack the discretionary element that defines a tip.
  • Managers, pools, and owners: A manager or supervisor may count a qualifying tip received directly for services personally performed, but may not count a distribution from a mandatory tip pool. The ownership anti-abuse threshold is at least 5% of corporate vote/value or partnership profits/capital, and more than 5% beneficial ownership of another entity, tested when the tip is received; an amount within the rule is irrebuttably recharacterized.
  • Excluded forms and activities: Digital assets, in-kind property, subscriptions, paywalls, and amounts received for pornographic activity are not qualified tips even when labeled tips, gifts, or donations. The receipts remain taxable income.

FICA is still owed: The tip deduction only reduces federal income tax. Social Security and Medicare taxes (7.65% combined employee share) are still calculated on tip income. Your employer is required to withhold FICA on reported tips. For 2026, the Social Security wage base is $184,500 - tips count toward that base.

Dollar Examples for NJ Workers

Example 1: NJ Restaurant Server (Single Filer, 2026)

Notice the placement of the §224 deduction. It applies AFTER AGI and the standard deduction, not before. This matters because AGI stays at $65,000 for purposes of every other tax provision that uses AGI or MAGI (EITC, CTC, IRA deductibility, Marketplace subsidies, etc.).

Reference tableSwipe to view all columns →
LineAmount
Non-tip wages$43,000
Reported tips (included in W-2 Boxes 1 and 7; qualified amount separately reported for 2026 with Box 12 code TP and the occupation field)$22,000
Federal AGI (= W-2 Box 1 here; this example assumes no other income and no above-the-line adjustments)$65,000
Less: 2026 standard deduction (single)($16,100)
Subtotal$48,900
Less: §224 tip deduction (Schedule 1-A → Form 1040 line 13b)($22,000)
Federal taxable income$26,900
2026 federal income tax (10% / 12% brackets)~$2,980

Computing tax on $26,900 of 2026 taxable income for a single filer per Rev. Proc. 2025-32 (Table 3, unmarried individuals): 10% on the first $12,400 = $1,240, plus 12% on the next $14,500 (from $12,401 up to $26,900) = $1,740. Total ≈ $2,980. Without §224, taxable income would have been $48,900 and the 2026 single tax would have been ≈ $5,620 ($1,240 + 12% × $36,500 = $4,380; the 22% bracket does not begin until $50,400 of taxable income for single filers under Rev. Proc. 2025-32). Federal savings from §224 ≈ $2,640. Multiplying the $22,000 deduction by a 22% marginal rate would overstate the benefit; on these facts all of the tip income sits inside the 10%/12% brackets.

NJ result: NJ taxes the full $65,000 in income. NJ does not conform to §224. At NJ's graduated rates (1.4% to 5.525% for this income level), approximate NJ GIT is ~$2,100 (before the $1,000 personal exemption). The federal §224 savings do not carry over to NJ.

Example 2: Self-Employed NJ Barber ($60K Gross, $15K in Tips, 2026)

The final §224 regulations (Treas. Reg. §1.224-1) allow self-employed workers in listed occupations to claim the deduction when every requirement is met. Barbers and cosmetologists are on the list. In this 2026 example, the $15,000 qualified-cash-tip amount and TTOC must be separately reported in the new tip fields on an applicable Form 1099-NEC, 1099-MISC, 1099-K, or another specified statement. The barber reports all $60,000 of business receipts on Schedule C, but Schedule C and bank-deposit records do not by themselves create Section 224 eligibility.

Self-employed mechanics:

  • Schedule C net income (gross minus deductible expenses) must equal or exceed the §224 deduction claimed. The deduction cannot exceed net trade-or-business income.
  • Tips must be voluntary. Mandatory salon service charges, automatic gratuities on packages, and added-on 'service fees' do not qualify.
  • For Section 224, apply Notice 2025-69's temporary SSTB transition rule while the final-regulation subsection remains reserved. That treatment does not itself decide the barber business's separate Section 199A classification.
  • Apply the direct-ownership anti-abuse rule to the payor: at least 5% of corporate vote/value or partnership profits/capital, or more than 5% beneficial ownership of another entity, triggers irrebuttable recharacterization when the amount is received.

Booth renter / cash-tip documentation: Daily tip logs, POS reports, receipts, and deposit records remain important substantiation, but they do not replace the 2026 separate-information-statement rule. Notice 2025-69 provides a different 2025 transition path only when a nonemployee's tips were included in an applicable aggregate 1099 box and corroborating records reconstruct the amount. A booth renter with no applicable 2026 statement cannot create eligibility merely by issuing no form to themselves and using the daily-log total.

Greg Monaco, CPA: Track every tip and report all business income, whether or not a payer issues a form. Then test deduction eligibility separately. For 2026, first locate the separately reported qualified-cash-tip amount and TTOC; use the logs and POS records to corroborate that statement, not to replace it.

The NJ Conformity Problem

On December 1, 2025, the New Jersey Division of Taxation published official OBBBA guidance confirming that the new federal tip, overtime, and senior deductions 'do not affect a taxpayer's New Jersey Individual Income Tax return.' This is now controlling state-level guidance. All tip income earned in New Jersey remains fully taxable under the NJ Gross Income Tax regardless of any federal §224 deduction claimed. Conformity would require enacted NJ legislation. A1278 (opens in a new tab) and A3691 (opens in a new tab) were introduced in the 2026 session, but neither has been enacted as of this article's July 29, 2026 review. Pending proposals do not change current NJ return treatment. See also our NJ OBBBA Deductions Conformity Guide for the broader NJ non-conformity picture.

NJ tipped workers therefore face a federal/NJ income split on their 2025 and 2026 returns:

  • Federal return (Form 1040): When eligible, report tips as income (they remain in AGI), then claim the allowable below-the-line §224 deduction on Schedule 1-A, which flows to Form 1040 Line 13b after AGI on Line 11.
  • NJ return (NJ-1040): Report employee tips in NJ wages or self-employed tips in the applicable business-income category. No corresponding §224 deduction applies.

The result is a federal/NJ computation difference that must be reconciled. Do not compare a single 'taxable income' total: Form 1040 and NJ-1040 use different bases, categories, exclusions, and deductions, so their intermediate amounts can differ for reasons beyond Section 224.

Practical impact on NJ estimated taxes: If you make quarterly NJ estimated payments (NJ-1040-ES), do not reduce the NJ computation by the federal tip deduction. Compute the estimate from the applicable NJ income categories, deductions, credits, and payment rules.

Employer Obligations Under the Tip Deduction

Employers in the food, beverage, and hospitality industries have new compliance considerations under §224:

  • W-2 reporting: Box 7 continues to report Social Security tips, but for tax year 2026 the qualified-cash-tip amount is separately identified with W-2 Box 12 code TP and the occupation field. The employer and its payroll provider are responsible for payroll capture, transmission, filings, and W-2 reporting; Monaco CPA may review client-supplied platform reports within a separately accepted written scope but does not transmit payroll data or forms.
  • FICA withholding: FICA must still be withheld on tips as before. The §224 deduction does not change FICA obligations.
  • Tip credit and credit card tips: Employers who receive credit card tips and distribute them to employees should continue standard procedures. Those tips remain subject to FICA and can qualify for the employee's §224 deduction when the voluntariness, occupation, reporting, filing-status, ownership, and other requirements are met.
  • NJ SDI/FLI: NJ state disability and family leave insurance premiums are calculated on NJ wages, which include tip income. The federal deduction does not reduce the base for NJ SDI/FLI calculations.

Industries Covered - and Industries That May Not Qualify

The IRS has published the controlling list at Treas. Reg. §1.224-1(h) ('List of Occupations that Receive Tips') and maintains it online at IRS.gov/TippedOccupations (opens in a new tab). Both Schedule 1-A and the regulations reference the same list. Covered occupations include:

  • Food and beverage service (servers, bartenders, bussers, food runners, delivery workers)
  • Hotel and hospitality (bellhops, valets, concierge, housekeeping)
  • Hair, nail, and beauty services (barbers, cosmetologists, estheticians, nail technicians)
  • Personal care and body work (massage therapists, spa workers, tattoo artists - tattoo artists ARE on the published list)
  • Casino dealers and casino service workers
  • Taxi and ride-share drivers receiving voluntary passenger tips (the rideshare-app cash-out itself is not a tip; rider gratuities passed through the app are)
  • Exercise trainers and group fitness instructors (IRS occupation code 608, including aerobics trainers, yoga instructors, and personal trainers), subject to the other eligibility rules
  • Other occupations on the published list (verify your specific occupation at IRS.gov/TippedOccupations)

Payments that do not qualify merely because of the worker's occupation:

  • Delivery app workers whose payment is a delivery fee, not a voluntary tip
  • Amounts received for pornographic activity, even when the occupation or platform otherwise appears on the list
  • Digital assets, property, subscriptions, paywalls, automatic gratuities, and mandatory service charges
  • Mandatory tip-pool distributions to managers or supervisors. A direct tip for services a manager personally performs can qualify if every other requirement is met
  • SSTB treatment requires the separate Section 224 transition analysis described above; do not import a Section 199A label without applying Notice 2025-69 and the reserved final-regulation subsection

When in doubt, look up your specific occupation at IRS.gov/TippedOccupations before claiming the deduction.

How to Claim the Deduction on Your Federal Return

The §224 tip deduction is a below-the-line deduction claimed on the new Schedule 1-A (Form 1040), Part II, which flows to Form 1040 Line 13b (after AGI on Line 11 - confirming the below-the-line placement). You do not need to itemize to benefit. Filers who take the standard deduction get the §224 deduction in addition.

Steps for W-2 workers:

  1. Gather all W-2s and any Form 4137. For 2025, use the transition instructions with Box 7, employer statements, and corroborating earnings records. For 2026, locate W-2 Box 12 code TP and the occupation field; other qualified employee tips can use the applicable Form 4137 path.
  2. Confirm your occupation appears on the Treas. Reg. §1.224-1(h) list / IRS.gov/TippedOccupations.
  3. Total your qualifying tip income across all employers (the $25,000 cap is per taxpayer, not per employer).
  4. Compute MAGI before §224 and apply the phaseout beginning at $150,000 single or $300,000 MFJ. Being above the starting threshold does not by itself eliminate the deduction; lines 10 through 12 reduce the otherwise allowable amount until it is fully phased out.
  5. If married, confirm you are filing MFJ - the deduction is not available for MFS filers.
  6. On Schedule 1-A Part II, line 7 is the capped qualified-tip amount before the phaseout; lines 10 through 12 compute the phaseout, and line 13 is the resulting deduction that flows to Form 1040 line 13b via the Part VI total (line 38).
  7. On your NJ-1040, report employee tips in NJ wages or self-employed tips within the applicable NJ business-income computation; do not claim the federal §224 deduction on the NJ return.

Steps for self-employed workers: Same as above except step 1. For 2025 transition relief, confirm the tips were included in an applicable aggregate Form 1099 box and reconstruct the amount with the documentary evidence Notice 2025-69 permits. For 2026, use the separately reported qualified-cash-tip amount and TTOC from the new fields on Form 1099-NEC, 1099-MISC, 1099-K, or another specified statement. A Schedule C total or self-reported log is not a substitute when the required 2026 statement is absent.

Tax-software support and data flow can vary by product, version, return type, and filing period. Verify the completed Schedule 1-A calculation and Form 1040 line 13b against the current instructions and the taxpayer records. On the NJ side there is no "add-back" to make - the federal deduction is below-the-line and never reduces NJ wages; reconcile the NJ-1040 to full W-2 Box 16 wages or the applicable full NJ business-income category rather than a federal figure net of Schedule 1-A.

Frequently Asked Questions

Are tips exempt from Social Security and Medicare tax under OBBBA?

No. FICA taxes (Social Security at 6.2% and Medicare at 1.45%, for a total 7.65% employee share) still apply to tip income. The §224 deduction reduces only federal income tax. Employers continue withholding on reported tips, and employees use Form 4137 to calculate their employee Social Security and Medicare tax on tips not reported through payroll.

Do I have to report my cash tips to my employer to claim the deduction?

Employees generally must timely report cash tips to their employer under the ordinary tip-reporting rules. If tips were not included through payroll, they still must be reported on Form 4137; current Schedule 1-A instructions allow the qualified Form 4137 amount to flow through line 4b. The deduction does not excuse late or incomplete employer reporting.

Does NJ have any plan to conform to the tip deduction?

On December 1, 2025, the NJ Division of Taxation issued official guidance confirming the OBBBA tip, overtime, and senior deductions do not affect NJ Individual Income Tax returns. This is now controlling NJ-side guidance. Conformity would require enacted NJ legislation. A1278 (opens in a new tab) and A3691 (opens in a new tab) were introduced in the 2026 session, but neither has been enacted as of this article's July 29, 2026 review. Pending proposals do not change current NJ return treatment. If the NJ Legislature later enacts a retroactive change, an amended NJ-1040 may become available under that law's effective-date and transition rules; the current proposals themselves confer no deduction.

Can my employer lower my pay because of the tip deduction?

This is a labor law question, not a tax question. The OBBBA tip deduction does not change minimum wage, tip credit, or NJ tipped minimum wage rules. Under NJ law, employers can claim a tip credit against the state minimum wage for tipped workers, but the tip credit rules have not changed because of OBBBA.

What if I received tips from multiple employers?

The $25,000 cap is per taxpayer, not per employer. Add up all qualifying tip income from all W-2 jobs, then apply the $25,000 cap to the total. If you received $14,000 in tips from your first job and $13,000 from a second job, you can deduct $25,000 total (not $27,000).

Does the tip deduction affect my eligibility for other credits?

No. The §224 deduction is below-the-line. It reduces taxable income on Form 1040 Line 13b after AGI is calculated on Line 11, so it does not itself reduce AGI or MAGI for provisions such as the EITC, Child Tax Credit phase-out, IRA deductibility, student-loan interest, or Premium Tax Credit. Apply each provision's own eligibility and phase-out rules to the completed return. The other Schedule 1-A deductions - overtime, car-loan interest, and the senior deduction - likewise do not reduce AGI.

Circular 230 Disclaimer: This article is provided for general informational and educational purposes only. It does not constitute legal, tax, or financial advice. Tax laws change frequently and the applicability of any information depends on your specific facts and circumstances. Consult a licensed CPA before making any tax-related decisions.

Related Articles: OBBBA Tax Changes for NJ Residents | W-2 vs 1099 in New Jersey | Self-Employment Tax Explained | NJ Tax Changes 2025 | Contact Form

Ready to File With Confidence?

Tax rules change frequently. Use the contact form to request a written scope; submitting it does not promise a call, engagement, or outcome. Greg Monaco is a NJ-licensed CPA and the firm's sole practitioner.

Use the contact form to request an intake review