When you file your taxes, you normally report ALL your income - both your service fees and tips - and pay federal income tax on the total amount. With this new law, you can now deduct up to $25,000 of tip income from your taxable income, meaning that portion won't be subject to federal income tax.
Example:
• Total income: $100,000 (services + tips)
• Tips received: $30,000
• Before: Pay federal income tax on full $100,000
• After: Pay federal income tax on only $75,000 ($100,000 - $25,000 tip deduction)
Who Qualifies - The Details
The deduction phases out for those earning over $150,000 ($300,000 for joint filers), and beauty industry professions, including hair stylists and nail techs, are specifically mentioned as qualifying occupations. However, there are some important nuances:
• Income limit: If you make exactly $150,000, you get the full deduction. As your income goes above $150,000, the deduction gradually decreases
• Tip qualification: The tip amount must be paid voluntarily, is not subject to negotiation, and cannot be built into the service total.
Your Savings Calculation
The savings depend on your tax bracket:
If you're in the 22% tax bracket:
• $25,000 tip deduction × 22% = $5,500 savings
If you're in the 24% tax bracket:
• $25,000 tip deduction × 24% = $6,000 savings
If you're in the 32% tax bracket:
• $25,000 tip deduction × 32% = $8,000 savings
What You Need to Do
1. Separate tracking: Keep tips separate from your service fees in your records.
2. Documentation: The deduction is allowed for employees receiving a W-2, independent contractors receiving a 1099-K (most popular among independents) or 1099-NEC, and taxpayers reporting tips on Form 4137.
Form 1099-K (Payment Card and Third Party Network Transactions)
This form tracks electronic payments.
What it is:
• Reports credit card and electronic payment transactions.
• Issued by payment processors (Square, PayPal, etc.).
When you receive it:
• If you process more than $600 in card transactions annually (lowered from $20,000 in 2022).
• Form comes from your payment processor.
What it shows:
• Total gross receipts from card/electronic payments.
• Number of transactions.
• Monthly breakdown.
Important note: This often includes both your service fees AND tips together, so you need to separate them in your records.
3. Annual reporting: When you file your 2025 taxes (in early 2026), you'll claim this as an above-the-line deduction
Important Limitations
• Still pay self-employment tax: This elimination doesn't affect payroll taxes for Social Security and Medicare - you still pay the full 15.3% on all income.
• Temporary benefit: The deduction is allowed from tax years 2025 through 2028.
• Federal only: This doesn't affect state income taxes in most states.
Real-World Scenario
Sarah, a stylist at Salon Lofts:
• Annual income: $120,000
• Tips: $35,000
• Tax bracket: 24%
• Benefit: Can deduct $25,000 (the maximum), saving $6,000 in federal income tax
• Still pays: 15.3% self-employment tax on the full $120,000
This is why the savings estimate is $4,000-$7,000+ - it varies based on your total income, tax bracket, and how much you receive in tips.
Ready to maximize your benefits from these historic tax changes? Consult with a tax professional experienced in beauty industry businesses to ensure you're taking full advantage of these game-changing provisions.
