Who Qualifies for No Tax on Tips?

Published September 26, 2025

In a September 24 article published by the National Taxpayers Union Foundation (NTUF), there is an explanation of the "no tax on tips" provision. This deduction was passed in the One Big Beautiful Bill Act (OBBBA). The NTUF article suggests this tax deduction will benefit a substantial number of individuals who receive voluntary tips. However, the deduction applies to individual income tax and not to the payroll tax. In addition, it will be important for all employees who receive tips to keep accurate records.

1. Income Tax Deduction — The new deduction exempts tip income up to $25,000 per year for single individuals and $50,000 per year for joint filers. The deduction is phased out for single individuals with incomes over $150,000 or a married couple with modified adjusted gross income over $300,000. It is applicable from 2025 until 2028. For example, a single individual with income of $45,000 in 2025 pays tax at 10% on the amount under $11,600 and 12% on the taxable income over that threshold. He or she can claim a standard deduction which will reduce taxable income by $15,000. Some individuals also may qualify for the Child Tax Credit (CTC) and Earned Income Tax Credit (EITC). These tax credits can potentially reduce the tax to zero. In 2022, an estimated 51 million taxpayers paid no federal income tax.
2. Payroll Taxes — While the new deduction is welcome, it applies to income tax and not to payroll tax. Payroll tax includes 6.2% for Social Security and 1.45% for Medicare. The 7.65% payroll tax is paid by both the employer and employee. The employer will need to record the tip amounts so that the correct payment is made for the employer tax. In addition, employers will need to withhold the 7.65% payroll tax for the reported tip income of employees. A high percentage of workers with income under $100,000 pay payroll tax. Approximately 70% of those taxpayers were paying payroll tax, but only 40% of them were subject to federal income tax. Because a substantial portion of tip income is self-reported, workers who receive this income need to ensure the amounts are reported to employers. With the correct amount reported to the employer, both the employer and employee 7.65% payroll tax will be paid.
3. Tip Income Reporting — The OBBBA "No Tax on Tips" law is a significant change for some taxpayers. However, it will require additional efforts to report the correct amounts. The Internal Revenue Service (IRS) has initiated the Tip Reporting Alternative Commitment (TRAC) and other systems to try to track tips. Because there are billions of dollars of tip income not reported, there will be continued efforts to increase the reporting of tips. A new initiative by the IRS is the Service Industry Tip Compliance Agreement (SITCA). This is still in the process of being implemented. With the new deduction, both employers and employees will want to be more accurate in tip reporting.

When employees who receive tips file tax returns, they will need guidance from the IRS. The IRS was required by OBBBA to specify the occupations that qualify for the tip deduction. The IRS has also issued a proposed Schedule 1-A that helps employees determine whether they qualify for the full tip deduction. If the wages for a single person are less than $176,100 on their W-2, then they can use the Schedule 1-A form to learn if they are qualified.

Employees also need to know whether their specific occupation qualifies. The IRS has published nearly 70 qualifying occupations under the Treasury Tipped Occupation Code (TTOC). The IRS also notes this deduction applies to voluntary cash tips. Cash can include tips paid with credit cards, debit cards, casino tips or gift cards. Some restaurants with a mandatory service charge may change policies to allow a voluntary tip that qualifies for the new deduction.

The Yale Budget Lab estimated in 2022 that approximately 37% of tipped workers paid no federal income tax. These individuals will not be affected by the new deduction. However, individuals in higher tax brackets who receive tips will significantly benefit from the “no tax on tips” deduction.

Universities and the New Endowment Tax

Tax Notes has done an analysis of the probable excise tax to be paid by private colleges and universities. The One Big Beautiful Bill Act (OBBBA) replaced the existing 1.4% tax on net investment income (NII) with a three-tiered rate structure. The new excise tax is based on the size of the endowment and the number of full-time students.

Tax Notes suggests that five universities will be subject to the highest tax of 8% because their endowments are over $2 million per student. An estimated eight schools will pay a 4% tax because their endowments are between $750,000 and $2 million per student. Schools with student-adjusted endowments between $500,000 and $750,000 remain subject to the existing 1.4% tax.

The five universities with large endowments may pay taxes from an estimated $80 million to $175 million. Tax Notes’ estimates are based on 2023 endowment values. Yale University with an endowment of $41 billion will change from an estimated tax of $30 million to $175 million. Harvard University, with an endowment of $51 billion, will have an estimated tax increase from $25 million to $142 million. Princeton University has $35 billion of endowment and an estimated tax increase from $24 million to $139 million. Stanford University with a $36 billion endowment will pay $85 million in excise tax. Finally, MIT with $25 billion of endowment should increase from $14 million to $81 million.

Some large universities estimate that by 2026, endowments will increase, and the excise tax may grow to amounts much greater than Tax Notes’ projection.

The eight universities in the 4% bracket include the University of Notre Dame with $17 billion in endowment and an estimated $32 million in tax. The University of Pennsylvania has $21 billion of endowment and an estimated $27 million in tax. Emory University has $11 billion of endowment and $23 million in tax. Washington University in St. Louis has $12 billion of endowment and $22 million in tax. Vanderbilt University, with $10 billion of endowment will expect to pay $16 million in tax. Rice University has an $8 billion endowment and will face tax of $11 million. Dartmouth College has $8 billion of endowment and an estimated tax of $11 million. The University of Richmond with a $3 billion endowment will expect to pay $6 million in tax. Once again, the 2023 estimates will scale up to a level significantly higher than what was projected by Tax Notes.

A number of private colleges and universities will be subject to the 1.4% tax. The tax is applicable under OBBBA to private colleges and universities with 3,000 full-time-equivalent, tuition-paying students. This is up from the previous threshold of 500 students. There will be a significant number of colleges with over 3,000 qualifying students and endowments over $500,000 per student who pay the 1.4% tax. However, there are an estimated 26 private colleges with more than 500 students but less than 3,000 students who previously paid the 1.4% excise tax. These private colleges will not pay tax under OBBBA.

Conservation Easement Deductions "Too Good to Be True"

In Jackson Stone South LLC v. Commissioner; No. 12271-20; No. 12274-20; T.C. Memo. 2025-96, the Tax Court considered two conservation easement cases and reduced the deductions from $19 million to $405,000 in one case and $19 million to $460,000 in the second case.

Real estate developer, Howard Brian Jackson, and his family had been investing in the Central Georgia area for seven decades. They owned multiple properties in Jones County, Georgia. In 2016, the Jackson family partnership sold two parcels of property for $2.5 million to Jackson Stone South, LLC (JSS) and Jackson Stone North, LLC (JSN). Both partnerships were syndicated with multiple investors. They then transferred conservation easements to the Oconee River Land Trust, Inc. (ORLT). JSN transferred an easement on 253 acres and JSS transferred an easement for 288 acres.

JSN and JSS secured appraisals from Dale W. Hayter who used a discounted cash flow (DCF) method and claimed the property could produce substantial granite over a period of years. Therefore, each property would qualify for a charitable easement conservation deduction of approximately $19 million. The IRS audited the two partnerships and denied both charitable deductions.

At the Tax Court trial, JSN and JSS presented multiple expert witnesses. Taxpayer appraiser James C. Clanton used a discounted cash flow analysis to claim that a granite mine was the highest and best use and justified the deductions.

The IRS presented multiple experts. IRS appraiser Raymond H. Krasinski indicated the DCF method was not acceptable. It was "not directly connected to demonstrated actions of buyers and sellers of vacant land in the local market." The IRS contended the valuation was dependent upon assumptions as to zoning and financial feasibility that were incorrect. IRS real estate appraiser Andy D. Sheppard offered analysis on comparable properties. There had been no new granite mines in the surrounding area that were deemed viable by investors for at least two decades.

The IRS contended that Hayter was not a qualified appraiser and that the appraisal included multiple defects that did not comply with the code. In addition, the appraisal failed requirements under Reg. 1.170A-14(g)(5)(i) because it did not include a detailed record to support the conservation easement. The IRS contended that the materials submitted did not fulfill this required level of detail.

The Tax Court determined that Hayter was a qualified appraiser. Hayter holds the Member of the Appraisal Institute (MAI) designation, holds himself out to the public as an appraiser, did not have a personal interest in the value and therefore was a qualified appraiser. The appraisals must be qualified under Section 170(f)(11)(E). This requires an appraisal be "in accordance with generally accepted appraisal standards." While the IRS contended that the appraisal was not consistent with Uniform Standards of Professional Appraisal Practice (USPAP), the Tax Court stated there were flaws but that it was in compliance.

Therefore, the primary issue was the valuation of the easements using a "before and after" method. The method allows a determination of the highest and best use.

However, the taxpayer’s use of DCF was rejected. The DCF valuation was based on assumptions that the Tax Court deemed "too good to be true." The economic feasibility of a new granite mine in an area that had not had granite mines opened for a significant period of time was deemed unlikely. In addition, a new granite mine would require rezoning and this was quite uncertain. Therefore, the Tax Court determined "mining was not a legally permissible use" of the two properties.

The IRS report that analyzed comparable values was deemed applicable. The comparable sale prices were far below the taxpayer’s estimate, which was approximately $68,000 per acre. The IRS average sale per acre estimate was $2,637. Because the Tax Court determined it was "highly unlikely" that the granite mine could be financially viable, it accepted the valuation of IRS expert Sheppard. Therefore, the easement values for JSS and JSN were deemed to be $460,000 and $405,000, respectively.

The IRS argued the partnership assets should be considered ordinary income and deductions limited to basis under Section 170(e). The Tax Court rejected the IRS claim that the deduction should be limited to basis.

However, the Tax Court determined the reported deductions of $19 million for each parcel were 4,040% and 4,602% overvalued. Therefore, the valuation error was both substantial and gross and the 40% gross valuation misstatement penalty under Section 6662(h) was applicable. To the extent that any of the underpayment was due instead to negligence or substantial understatement, a 20% penalty was applicable.

Editor's Note: The IRS continues to win conservation easement valuation contests. Although both the appraiser and appraisal were accepted, the charitable deduction was substantially limited, and the valuation was rejected as highly improbable.

Applicable Federal Rate of 4.6% for October: Rev. Rul. 2025-19; 2025-41 IRB 1 (15 September 2025)

The IRS has announced the Applicable Federal Rate (AFR) for October of 2025. The AFR under Sec. 7520 for the month of October is 4.6%. The rates for September of 4.8% or August of 4.8% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2025, pooled income funds in existence less than three tax years must use a 4.0% deemed rate of return. Charitable gift receipts should state, “No goods or services were provided in exchange for this gift and the nonprofit has exclusive legal control over the gift property.”