Tip Deduction up to $25,000 (2025–2028): How Restaurant, Nail, and Massage Workers Can Plan Compliance

Author: Gloria Liu, CPA ｜ YCL Tax, Accounting & Advisory

Bottom line in one breath

If you work in Cary / RTP / Raleigh restaurants, bars, nail salons, massage or spa businesses, hotels, or other tip-customary jobs: the One Big Beautiful Bill Act (OBBBA, P.L. 119-21), signed July 4, 2025, added IRC §224, allowing a federal income-tax deduction of up to $25,000 of qualified tips for tax years 2025–2028 (phased out at higher MAGI). This is not “tips are tax-free,” and it does not automatically reduce North Carolina taxable income—NCDOR has said so in writing. Now is the time for recordkeeping, occupation matching, and filing compliance planning.

Background

Tips have long been included in federal taxable wages/income and often appear in Form W-2 Box 7 (Social security tips) or on Form 4137. OBBBA §70201 created §224 for “qualified tips” received in occupations the IRS lists as customarily and regularly tipped on or before December 31, 2024, for years 2025–2028. IRS Fact Sheet FS-2025-03 summarizes the rules; Notice 2025-69 (IR-2025-114) gives 2025 transition computational methods; proposed regulations (about September 2025) list nearly 70 occupations (food/beverage, personal appearance & wellness including nail and massage, hospitality, and more). Separately, North Carolina’s Session Law 2026-31 updated IRC conformity to July 5, 2025, but NCDOR still states that the new OBBBA tip (and related) deductions do not reduce NC taxable income.

Old vs. new

1. Deduction: Old—tips generally fully taxable federally. New (§224)—qualified tips deductible up to $25,000 per year (hard cap regardless of filing status).

2. Years: 2025–2028 only; generally unavailable for years beginning after December 31, 2028.

3. Who qualifies: Occupation on the IRS tipped-occupation list; tips must be voluntary cash/charged tips from customers or tip-sharing. Automatic service charges the customer cannot refuse or modify are generally not qualified tips (proposed-reg view; final regs 待核 / verify).

4. Phase-out: MAGI over $150,000 ($300,000 joint): reduce deduction by $100 per $1,000 over the threshold.

5. How claimed: Available whether you itemize or take the standard deduction; computed on Schedule 1-A, flowing to Form 1040 line 13b—it does not reduce federal AGI.

6. Reporting & identity: Tips on W-2 / 1099 / specified statements or Form 4137; married taxpayers must file jointly; valid SSN required. Self-employed: deduction limited to net income from the tip-earning business. SSTB limits under §199A apply, with 2025 transition relief in Notice 2025-69 (details 待核).

7. FICA: This is a federal income-tax deduction; Social Security/Medicare rules on tips still apply—do not treat payroll taxes as wiped out.

8. North Carolina (critical): NCDOR FAQ (post–Session Law update Q14) — federal tips, overtime, car-loan interest, and senior extra deductions are taken after AGI and do not affect NC taxable income; the General Assembly did not create a parallel state deduction. 待核: future NC legislation—re-check each season.

Self-check: does this affect you?

1. You earn material tips in 2025–2028 in a Cary/RTP restaurant, salon, massage/spa, hotel, or similar role that may match the IRS list.

2. Tips are reported to your employer (W-2 Box 7 / Form 4070) or via Form 4137; or you are self-employed with 1099-K / tip logs.

3. Your MAGI may enter the phase-out range.

4. You file a North Carolina return and need to know federal savings ≠ NC savings.

5. You own a shop and must align employee tip reporting (and, separately, employer FICA tip-credit topics).

Simplified example (illustration only; ignores state tax modeling details, credits, SE tax, etc.)

Assume a Cary restaurant server, single, 2025 W-2 Box 7 shows $18,000 of social security tips, no Form 4137, MAGI below phase-out, occupation on the proposed list:

1. Federal: About $18,000 may count toward qualified tips and, within the $25,000 cap, support a §224 deduction (illustration), lowering federal taxable income; FICA on tips may still apply.

2. If MAGI is $160,000 single: Roughly $10,000 over $150,000 → about $1,000 phase-out reduction (illustration); compute under §224(b)(2).

3. North Carolina: The federal tip deduction generally does not remove those tip dollars from the NC tax base—NC still starts from federal AGI that includes tips (NCDOR).

Results vary; there is no one-size-fits-all answer.

Action timeline

1. Now: Keep shift tip logs, employer statements, and tip-pool rules; separate voluntary tips from mandatory service charges.

2. Match occupation: Use the IRS proposed/final Treasury Tipped Occupation Code list (nail/massage often under personal appearance & wellness). Rely on proposed regs until final—待核 final text.

3. 2025 filing season: Follow Notice 2025-69 and Schedule 1-A instructions; if W-2 lacks a separate tip line, use Box 7, Forms 4070, 4137, and allowed methods.

4. 2026+: Watch for redesigned W-2/1099 separate tip reporting.

5. NC returns: Do not copy the federal tip deduction onto Form D-400 as a state write-off. Budget federal savings separately from unchanged NC treatment.

What YCL can do

1. Reconstruct W-2 Box 7 / 4137 / tip logs and estimate §224 amounts and MAGI phase-out.

2. Preliminary screen of occupation-list fit and service-charge exclusions.

3. Schedule 1-A vs. North Carolina filing alignment so clients do not assume NC conformity.

4. Employer-side tip reporting hygiene; pointer to separate FICA tip-credit topics for beauty businesses.

5. Bilingual support from Cary (RTP) and Shanghai offices with CPA Chenchen Liu and Gloria—compliance planning, not shortcuts.

FAQ

Q: Are tips completely tax-free starting in 2025?

A: No. This is a capped, phased-out federal income-tax deduction with occupation and reporting tests. FICA may still apply. NCDOR states the deduction does not reduce NC taxable income.

Q: Do nail and massage tips qualify?

A: Possibly, if your occupation is on the IRS customary-tip list (proposed list includes personal appearance & wellness), tips are voluntary/qualified, and reporting rules are met. Mandatory service charges or list/SSTB failures can disqualify—verify case by case.

Q: If I deduct $20,000 of tips federally, does North Carolina tax drop too?

A: Generally no. NCDOR Session Law FAQ Q14: these OBBBA deductions are after AGI and do not affect NC taxable income unless the state enacts its own deduction.

Book a consult

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Disclaimer

This article is general tax information only and is not tax, legal, or investment advice for any person or business. Application depends on occupation, tip facts, reporting, MAGI, and current federal and state law. Follow the latest IRS, Treasury, and NCDOR releases. Items marked 待核 require pre-filing verification. Consult a licensed professional for advice specific to you.