Do Tips Affect Your Tax Refund? How Tipped Income Impacts Your Taxes

Do tips affect your tax refund? Yes, they do, but not in the way you might think. The No Tax on Tips deduction can reduce your federal income tax liability, but only up to a certain point. I've seen this firsthand with my own clients, and it's essential to understand how it works.

How Does the No Tax on Tips Deduction Work?

The No Tax on Tips deduction is a provision in the tax code that allows tipped workers to exclude a certain amount of their tips from their income tax liability. The deduction caps at $25,000 of qualified tips per year, and it phases out above $150,000 Modified Adjusted Gross Income (MAGI) for single filers and $300,000 for married filing jointly. It applies to tax years 2025–28. According to the IRS, “Qualified tips are tips received by an employee for service as a direct result of a customer’s bill” ("https://www.irs.gov/forms-pubs/about-form-8027";).

Eligibility and Phasing Out

To qualify for the No Tax on Tips deduction, you must have earned tips from a trade or business where you performed services for customers, such as serving food or drinks. The deduction is not available to employees who earn tips from non-trade or business activities, such as tips received from friends or family members. If your Modified Adjusted Gross Income (MAGI) exceeds $150,000 for single filers or $300,000 for married filing jointly, the deduction will be phased out. This means that for every dollar above the threshold, $1 of the deduction will be reduced ("https://www.irs.gov/forms-pubs/about-form-8027";).

Understanding FICA and the Tip Credit

FICA (7.65%) still applies to tips, which means you will still pay Social Security and Medicare taxes on your tips. However, you can claim the FICA tip credit on Form 4137 to reduce your FICA liability. According to the IRS, “You can claim the FICA tip credit if you received tips of $20 or more in a month from one or more employers” ("https://www.irs.gov/forms-pubs/about-form-4137";).

Reporting Tips to Your Employer and the IRS

You are required to report tips of $20 or more in a month to your employer. Your employer will then report the tips on your W-2 form in Box 14b. Large food and beverage establishments must also report tip income on Form 8027. According to the Treasury Department, “Employers of employees who receive tips of $20 or more in a month from one or more employers must report the tips on Form W-2, Wage and Tax Statement” ("https://home.treasury.gov/";).

Reporting Requirements

1. Report tips of $20 or more in a month to your employer.
2. Your employer will report the tips on your W-2 form in Box 14b.
3. Large food and beverage establishments report tip income on Form 8027.

To report tips to your employer, you will need to keep a record of your tips and report them to your employer on a regular basis. Your employer will then report the tips on your W-2 form in Box 14b. If you are a tipped worker, you may also need to report your tips on Form 4137 if you did not report them to your employer or if you need to claim the FICA tip credit.

Practical Tip: To keep track of your tips, consider using a separate bank account or spreadsheet to record your tips each month. This will make it easier to report your tips to your employer and ensure you are taking advantage of the No Tax on Tips deduction.

Steps to Take When Reporting Tips to Your Employer

1. Keep a tip record.
2. Report tips to your employer.
3. Claim the No Tax on Tips deduction.
4. Claim the FICA tip credit on Form 4137.

Worked Example

Let’s say you are a server who earns an average of $1,500 in tips per month. You work for a restaurant that is required to report tip income on Form 8027. At the end of the year, you have earned a total of $18,000 in tips. You can exclude up to $25,000 of your tips from your income tax liability, which means you can exclude $7,000 of your tips. You will still pay FICA taxes on your tips, but you can claim the FICA tip credit on Form 4137 to reduce your FICA liability.

Key Takeaways

Frequently Asked Questions