Tips have been taxable income in the United States since the modern federal income tax took effect in 1913, when the Revenue Act’s broad definition of compensation swept them in alongside wages and salaries. The question of when tips became taxable has more than one answer, though, because Congress added new layers of taxation and reporting over the following century: Social Security and Medicare taxes attached in 1966, formal reporting rules for restaurants arrived in 1982, and a temporary income tax deduction of up to $25,000 for qualified tips was created in 2025.
1913: The Income Tax Sweeps Tips In
The Revenue Act of 1913 defined taxable income broadly enough to cover any compensation for personal services, and that language reached tips from the start. Enforcement was another matter. Tips were cash, informal, and effectively invisible to the federal government, so the legal obligation existed long before any practical mechanism to collect on it.
In 1919, the Treasury Department made the rule explicit. Its Regulations 45, issued under the Revenue Act of 1918, listed tips alongside commissions and bonuses as income to the person who received them. That put the question beyond doubt as a matter of regulatory text, even if reporting compliance remained close to nonexistent.
1948: Roberts v. Commissioner Closes the “Gift” Argument
For decades, some tipped workers argued that gratuities were gifts rather than payment, and gifts to the recipient are not taxable income. The Tax Court rejected that reasoning in 1948 in Roberts v. Commissioner. A taxicab driver had claimed his tips were non-taxable gifts from passengers. The court held that “the tips paid to the petitioner were income to him” because they were compensation for service, not acts of generosity. After Roberts, no serious legal argument remained that tips fell outside the income tax base.
1966: Tips Become Subject to Social Security and Medicare
Even after Roberts, tips sat outside the Social Security system entirely. Workers whose earnings came mostly from tips built little Social Security credit, which meant lower retirement and disability benefits later in life. Congress addressed that through the Social Security Amendments of 1965, effective January 1, 1966.
The new law required any employee who received $20 or more in cash tips during a calendar month to report those tips to their employer. The employer then had to treat the reported amount as wages for income tax withholding and for collecting the employee’s share of FICA, the combined Social Security and Medicare tax.1Treasury.gov. Federal Insurance Contributions Act (FICA) Tip Credit From that date forward, reported tips carried the same payroll tax burden as any other wages, at least on the employee side.
1977 and 1987: Employer FICA Catches Up
The 1966 law left a gap. Employers were not required to pay their own matching share of FICA on tip income. A 1977 change closed part of the gap by requiring the employer match, but only on tip amounts up to the federal minimum wage. Congress finished the job in 1987, extending the employer FICA obligation to cover all reported tip income rather than just the portion up to minimum wage.1Treasury.gov. Federal Insurance Contributions Act (FICA) Tip Credit That is the system still in place: once tips are reported, both halves of FICA apply.
To offset the added cost, Congress simultaneously created the Section 45B credit. It reimburses food and beverage employers, and certain personal-service businesses like barbershops and salons, for the FICA taxes they pay on tips above what would be needed to bring the employee up to federal minimum wage.2Office of the Law Revision Counsel. 26 US Code 45B – Credit for Portion of Employer Social Security Taxes Paid With Respect to Employee Cash Tips
1982: TEFRA Adds Formal Reporting for Restaurants
Reporting compliance remained weak long after 1966. The Tax Equity and Fiscal Responsibility Act of 1982, or TEFRA, targeted the problem at large food and beverage establishments, defined as operations with more than ten employees on a typical business day where tipping is customary.3Internal Revenue Service. 2025 Instructions for Form 8027 – Employers Annual Information Return of Tip Income and Allocated Tips
TEFRA required these establishments to compare total reported tips against 8% of gross receipts. If employees collectively reported less, the employer had to allocate the shortfall among tipped workers and report it to the IRS. That gave both sides an incentive to comply. Employers took on paperwork, and employees who underreported risked seeing allocated amounts appear on their W-2s. The 8% rule is still the framework restaurants operate under today.
2025: A New Deduction for Qualified Tips
The biggest change to tip taxation since TEFRA came in July 2025, when the reconciliation bill known as the “One Big Beautiful Bill” created a federal income tax deduction for qualified tip income. The popular shorthand “no tax on tips” overstates what the law actually does. It is a deduction, not an exemption, and tips remain subject to Social Security and Medicare taxes.
Eligible employees and self-employed workers can deduct up to $25,000 in qualified tips per return. The deduction phases out for taxpayers with modified adjusted gross income above $150,000, or $300,000 for joint filers, decreasing by $100 for every $1,000 over the threshold.4U.S. Department of the Treasury. Treasury and IRS Issue Proposed Regulations Around No Tax on Tips Only workers in occupations that customarily and regularly received tips before 2025 qualify. That limits the deduction to roles like restaurant servers, bartenders, barbers, and salon workers rather than opening a new incentive for industries where tipping was not already the norm.
For the 2025 tax year, taxpayers can claim the deduction using tip amounts from their existing records or Form 4070 reports.5Internal Revenue Service. Guidance for Individual Taxpayers Who Received Qualified Tips Starting with 2026 returns, only qualified tips that are separately identified on a Form W-2, 1099, or Form 4137 will be deductible. The provision covers tax years 2025 through 2028. If Congress does not extend it, tips revert to fully taxable status in 2029.
What Is Still Taxable
The 2025 deduction reduces income tax on qualified tips for eligible workers up to the cap, but it does not remove tips from the tax system. FICA still applies. Employers still withhold Social Security and Medicare taxes on reported tips, and employees still owe those taxes even on tips they claim as a deduction.
One category of payment is not covered by tip rules at all: a mandatory service charge added to a bill is not a tip, even if the employer passes it through to employees. The IRS looks at four factors, and a payment counts as a tip only when the customer makes it voluntarily, decides the amount without restriction, faces no employer-dictated policy about it, and chooses who receives it.6Internal Revenue Service. Tips Versus Service Charges – How to Report If any element is missing, the payment is a service charge and is taxed as regular wages, with full employer withholding and no eligibility for the 2025 deduction.