Ep. 159 | The IRS Says No Tax on Tips?
Download MP3Hey everyone and welcome back to the Teaching Tax Flow podcast. Today on episode number 159, we are exploring just what in the world the IRS means by no tax, on tips. But first, let's hear from our episode sponsor.
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John Tripolsky:Hey, everybody, and welcome back to the teaching tax flow podcast. Today, we're gonna jump directly into something we know that there's a lot of interest about, a lot of confusion, but one thing that there might not be is tax on these tips. So we're about to start talking. Again, this is the output of the one big beautiful bill act that I'm sure everybody's heard a lot about. And you don't wanna hear it from me.
John Tripolsky:We brought Chris Pacquero back to his own show as always, the man with all the knowledge around here for the most part. How's it going, man? How are you doing?
Chris Picciurro, CPA:It's going well. How are you doing today?
John Tripolsky:Hey. Pretty good, man. No room for dad jokes today. We're jumping straight into this thing again because I think we're gonna, we're gonna cut the BS, we should say, and really say what this is. And is it is it literally as clear as that the IRS is not going to charge any tax on any tips Right.
John Tripolsky:Anybody receives. Is that the case?
Chris Picciurro, CPA:Wouldn't that be easy? Then we wouldn't do a podcast if we just do a one minute reel. Exactly. No. That it's not that easy.
Chris Picciurro, CPA:Now we know during the most recent presidential election, there's a lot of talk about not taxing tips. So part of the one big beautiful bill act, which obviously had to have bipartisan support, was the concept of no tax on tips, and that actually comes into effect in 2025, the 2025 tax year. Now it's not that easy. Right? There are some rules and regulations I'm gonna work through to determine if your tips are exempt from federal income tax.
Chris Picciurro, CPA:Now there's not gonna be exempt from self employment tax, so they're not gonna be exempt from payroll tax. But let's talk about what's going on because there wasn't, like, had a part of the one big beautiful bill act. This is a temporary rule change that's gonna affect tax years 2025 through 2028 for now. No coincidence that that is the term of this, the current president. So we will see depend if this is something that gets discussed, extended with the next presidential election.
Chris Picciurro, CPA:But right now, we know from '25, '26, '27, '28, these four tax back these four tax years, there is a no tax on tip rule. And what does that mean? Well, let's tip the workers deduct up to $25,000 of tips from their taxable income. As you said, John, it's not a automatic deduction. There are qualifications.
Chris Picciurro, CPA:There are income phase outs. There are industry specific requirements. We're gonna dive into that. Right?
John Tripolsky:And this, honestly, out of everything that we heard leading up to when that bill was signed, this is on I mean, speaking for myself, this is the one that really surprised me, I think, that made it all the way through. I mean and, again, I think it it leads a little bit to the the, we'll say, not miscommunication, but kind of the confusion maybe of somebody thinking kinda like how how I did at that time. They're like, oh, they're not gonna tax any tips. Well, it's a lot of income that's in the system or maybe not in the system, which I'm sure we're gonna chat on a little bit too. Why would they do that?
John Tripolsky:That's like the IRS giving away free money. It's like them going down the roads and just, you know, throwing checks out or something like that. So, yeah, when as we walk through this, I'm sure we're gonna uncover that a little bit too.
Chris Picciurro, CPA:Absolutely. So this is a so something to consider. This is available to both employees and independent contractors or self employed individuals. So most namingly, you know, self employed people, like, that receive tips, who would that be? Well, Uber drivers, Lyft drivers, taxicab, DoorDash, all those type of of self employed people in in a variety of different musicians.
Chris Picciurro, CPA:You know what I mean? So they're self employed. They receive tips, so they have they're eligible. Let's first define what a qualified tip is. Qualified tip, this is very important, is a voluntary cash or credit card tip received directly from customers through or through tip sharing.
Chris Picciurro, CPA:So, John, you know, I worked in restaurants before. Many people have. Tip sharing is know, let's say there are four bartenders, and they just all throw the tips into the to a pool, either paid electronically or paid cash, and then they then they share them out. Very important term there, voluntarily. I was recently on a trip, with our family.
Chris Picciurro, CPA:We met up with a another family. We went out to a restaurant, got crap service. So I'm not I'd love to throw this restaurant under the bus, but I'm not going to. But because there was eight of us, they decided that we were gonna get charged an 18% service charge because we had a, quote, large party, which in this case gave them a green light to give crap service. Now that being said, that was not a voluntary tip.
Chris Picciurro, CPA:That was that was assessed to our table as a service charge. Anything above the that would have been voluntary on our part, and l and that server would have been eligible to exclude that tip from their income. So this is where I think we're gonna see a lot of reporting issues in a lot of restaurants maybe changing things up from that service charge or whatever they call it when you have an automatic tip amount or not with a big party to it being voluntary. So, remember, qualified tips have to be voluntary. As I mentioned, FICA tax or Social Security, Medicare, and self employment tax still apply.
Chris Picciurro, CPA:So this is a reduction of federal tax. You're gonna have to check with your state if your state's gonna comply with the federal tax rule. Right? Because not every state is gonna comply with those rules.
John Tripolsky:And I'm glad that we we hit that nail on the head pretty early on too about the voluntary part because I think that was one even when I learned about that semi recently, it's not shocking, but I'm glad to see it. Because otherwise, it's like, you know, from a consumer standpoint, it's one thing, but you're right. The it this, I can imagine already is gonna be so complex. Because how are you gonna categorize all these things, and what's the goals of it? How are you said, like, how are restaurants, etcetera, gonna gonna adjust?
John Tripolsky:You know, are they gonna get rid of that model completely? Maybe. I don't know where it came from, frankly, to begin with. So we'll see. That'll be interesting, I think.
Chris Picciurro, CPA:So so you it has to be a voluntary tip, we know. It also has there's an occupational eligibility factor. So you have to be in an occupation that has is customarily and regularly received tips. On or before 12/31/2024, the IRS is publishing guidance as to what occupations are included. Alright?
Chris Picciurro, CPA:Definitely. Check out the teaching textual YouTube channel. We have an entire playlist just on OB three, and we break down what those occupations are, but it has to be typically a occupation where you receive tips. Also, it can't be what we call an SSTB. SSTB stands for specialized service trader business.
Chris Picciurro, CPA:That's a concept that came out with the Tax Cuts and Jobs Act of 2017. So, ultimately, that includes people that are like doctors, lawyers, accountants, financial advisers. So if you are a, you know, a a attorney and you do a estate plan for someone, right, and it's a flat fee and that client gives you a $500 tip, that's great. It's taxable income. Are It's not gonna qualify because you are in an ineligible occupation because you're in the specialized service trader business.
Chris Picciurro, CPA:So make sure you're following the teaching title YouTube channel and checking out the IRS website to determine if you are in an a qualified occupation. I mean, transportation, you know, salons, all those type of of of occupations have been identified.
John Tripolsky:And I'll hit myself with a dumb dumb hammer because I forgot what episode it was, but I remember I cream up with some crazy example that, well, wouldn't just a plumber then start charging a dollar for a thousand dollar service and just tell the person to give him a, you know, a $999 tip, and then he's good? But this right here is gonna completely keep that from happening. Right? Because otherwise, I mean, you wouldn't get an invoice. You'd get a tip request or something.
John Tripolsky:Right?
Chris Picciurro, CPA:Exactly. So, I mean, again, bartenders, wait staff, food servers, anyone in that, you know, in that industry, bakers, gambling dealers. Right? That's a customary occupation. Singers, dancers, musicians, DJs.
Chris Picciurro, CPA:These are just examples. Ushers.
John Tripolsky:Yeah.
Chris Picciurro, CPA:You know? Ticket takers, people that work in a locker room, people that shine shoes at the airport, concierge. So, basically, when I lay
John Tripolsky:my head down at night and go to sleep in in my dreams, when I'm a singer, a dancer, entertainer, you know, hoping I was, hey. You know, I I wanna have to pay tax on on my dream tips.
Chris Picciurro, CPA:Maids, barbers. Anyway, there's a whole golf caddy, so there you've gotta be in that qualified occupation. Now there's an income threshold. What does that mean? Well, what a threshold means is that if you exceed a certain amount of income, modified adjusted gross income, then you're ineligible for this deduction.
Chris Picciurro, CPA:Now this deduction is unique because it's not an itemized deduction. What that means is that you could be a nonitemizer and still get the deduction, And it's kind of a weird thing because it's not necessarily above the line. It's not below the line. I heard it referred to by tax professionals between the line deduction, and I'm gonna steal that. This deduction is reported on a schedule one a.
Chris Picciurro, CPA:Again, sound like a shameless plug, but do yourself a favor and check out. We have content on that schedule. Or if you're just thinking about this and you have a direct question, jump into the defeating taxes private Facebook group, defeatingtaxes.com. That's the teaching tax flow group. And and and say, hey.
Chris Picciurro, CPA:I do this. Am I an eligible profession? We're happy to help. So income phase out, though. So if your income is too high, you get phased out of the deduction.
Chris Picciurro, CPA:For someone that's single, that's a $150,000. For a married filing joint couple, that's $300,000. So once you hit that income threshold, you start losing part of that deduction, and there's a formula for that to but you are ultimately fully phased out at 400,000 single, five fifty joint. So that's where anywhere between an married joint 300 and five fifty, you're still getting some type of tip deduction. Anything between $1.50 and 400 single, you're still getting your tip deduction.
Chris Picciurro, CPA:You might be thinking yourself, dang, $400,000. How many people make $400,000 and get and and a lot of it and actually get tipped? You know, think about people in Las Vegas. Servers at a nicer restaurant. I mean, they can make hundreds of thousands of dollars easily.
John Tripolsky:Absolutely. And that was exactly what was coming to mind when you were saying that is, know, those are some of the best careers in certain geographic areas, tourist destinations. Some of them make a big killing.
Chris Picciurro, CPA:Now a couple of things you gotta understand. To get this deduction, you have to have a Social Security number on your return. Can't be an ITIN number. And married couples have to file jointly to claim the deduction. Why?
Chris Picciurro, CPA:Because of the phase out. So if you're one of the advantages you know, we talk about married, joint, married, separate filing. You have to file jointly to be eligible for that tip deduction. Deduction. Now Now that that tip's tip's gonna gonna be be reported reported on on either either a a w w two, two, a ten ninety nine, or it could be reported on a form 30 forty one thirty seven, which is a voluntary you're voluntarily saying, hey.
Chris Picciurro, CPA:I've got cash tips, IRS. But, ultimately, the best thing is for employers to report those tips on those year end, you know, year end forms. So that those forms are gonna change starting in 2026. So, again, the most important thing is to keep track of your tips if you are a tipped employee or tipped, self employed person, and and be ready to report that when you have your tax return prepared, either self prepared or by, you know, by a professional. Wanna wrap up with a couple examples because, you know, I love case studies.
Chris Picciurro, CPA:Whenever I teach, I love case studies, and that they're just easy to kinda digest. Right? So let's talk about that server. That server earned $20,000 in tips. It has a $50,000 w two wage.
Chris Picciurro, CPA:For that server, assuming they're single, they would be able to deduct the full $20,000 in tips. Remember that max is $25, but it's a lesser of your tips or the $25,000 max, and they they would be able to take $20,000 off their taxable income on their federal tax return. Let's say you're a self employed masseuse. You earn $25,000 worth of tips in your net income. Let's say you work only at you know, your net income was $22,000 after expenses.
Chris Picciurro, CPA:Well, you can deduct $22,000 from income. So if you're self employed, right, your tip deduction is gonna be the lesser of your $25,000 or your net income. Right? So if your net income is less than the 25, you you take that. So and then, you know, let's say you're you're a married couple and you have $320,000 of modified adjusted gross income.
Chris Picciurro, CPA:One of the spouses received, you know, $28,000 of tips. Okay? Well, the maximum reduction is $25, but they're over the 300, you know, the $300,000 modified adjusted gross income threshold, so they get phased out of a couple thousand but still get a $23,000 deduction. So these are just quick examples. If you are listening or know someone that is in a tipped profession, make sure that you're keeping track of what these tips are.
Chris Picciurro, CPA:Make sure you talk to your tax professional to ensure you're gonna get the best result possible, and you could properly report these tips and hopefully deduct them off of your federal income tax return and maybe your state return.
John Tripolsky:Yeah. And you had two good points there as we wrap. Right? You have claiming it for one or reporting it, and then obviously when it comes, quote, unquote, tax time. I'm doing my air quotes here.
John Tripolsky:So as you do that, we are gonna go through this in a lot of depth. I imagine over and over and over again as it starts to really hit the ground running, we're gonna be touching on this from various different angles. So if anybody's listening, watching this, be on the lookout. We're gonna have more and more and more as it rolls out. We figure out more, employees figure out more, our employers figure out more, and individuals figure out more.
John Tripolsky:So that's what we're here for. Teaching Tax Full of the podcast. Subscribe if you haven't yet. Don't be lazy. Check it out, and we'll see everybody back here again next week on the show.
John Tripolsky:Same day of the week, different date, completely different topic. Have a great week, everybody.
Chris Picciurro, CPA:Oh, yeah. Oh, and one and more tips. Take care. Of course, more tips.
John Tripolsky:That's what we're here for, but we won't tax you on them. On that note, have a great week. We'll see everybody real soon.
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