OB3 - What You Need to Know (Pt. 1)
The One Big Beautiful Bill or OB3 - a name we’re crediting to Tom Gorczynski of Compass Tax Educators - was a hot topic during Spring & Summer of this year. The bill, passed July 4, 2025, provided for three major new tax deductions and a multitude of other updates to the tax code. Let’s break down the three big highlights and our recommendations for navigating each as well as a few other updates that you will need to know for this upcoming season.
Important note: much of the marketing around this bill focused on eliminating tax on certain items. This is not the case for the actual tax law. The following serve to reduce taxable income by deduction, but it does not fully eliminate the taxability of these items.
Tips Deduction
OB3 provided for a new tax deduction for qualified tips received up to $25,000 per year per return. Significant deduction, right? But what’s a “qualified” tip?
Qualified tips are any cash tip received by those who are in an occupation that usually & regularly receives tips. Examples include those in the food & beverage industry, home services, and personal services. For a full list of qualified professions, click here to view the Treasury regulations.
A cash tip does not have to come in the form of cash alone. Tips can also be paid by credit card.
Tips must be paid voluntarily. What does that mean? Service charges, automatic gratituties for large parties, or any other amount the business requires the consumer to pay is not a qualified tip and can not be included in the deduction.
The Details
Applies to tips received in tax years 2025 through 2028.
The total deduction is limited to $25,000 per tax year and it is a deduction subject to phase out limitations. If your adjusted gross income - that’s pre-standard deduction - is more than $150,000 ($300,000 for joint filers), you will see the total available deduction lower.
Married tax payers must file a joint return to receive this deduction.
You must include your social security number on your tax return - not available for ITIN holders.
Self-employed? Tips can only be deductible to the extent of your net income. If your net income is $500 and total tips are $1000, you will only be able to deduct $500.
What to Watch For
Employers & payroll providers will be required to update the procedures used to calculate tax withholdings on tips after December 31, 2025. That means that for the 2025 tax year, we have to use a bit of a hodgepodge of documents to calculate your eligibility for this deduction.
Self-Employed/1099 Contractors
Tips must be included on one of these forms to be eligible:
Form 1099-NEC, nonemployee compensation
Form 1099-MISC, miscellaneous compensation
Form 1099-K, Payment Card and Third Party Network Transactions (Paypal, Square, etc)
IRS transitional guidance for tax year 2025 allows us to use the following earnings statements or other documentation to make sure we’re capturing qualified tips - think monthly sales reports from your point-of-sale system, receipts, daily tip logs. These amounts must be included on the 1099-NEC, 1099-K or 1099-MISC.
W-2 Employees
Tips must be included on either your W-2 or you must report qualified tips on Form 4137 - Unreported Tip Income. There are changes coming to Form W2 for the 2026 tax year but for now in 2025, IRS transitional guidance allows us to use the amount that will be reported in box 7 or box 14 if your employer voluntarily chooses to report.
Our Recommendations
So how do we make sure you get the most out of this new deduction?
For self-employed taxpayers, we recommend that you receive all tips through a method that is going to result in a 1099 - think Square, Clover, Toast, etc. Cash tips aren’t going to qualify here if you’re self-employed.
For W2 employees, pull a copy of your year-end paystub and upload that along with your W2. This is going to allow your tax preparer to determine the source of all your pay for 2025 and apply deductions appropriately.
Sources:
Gorczynski, Tom. Compass Tax Educators. Federal Tax Update (2025)
Wolters Kluwer, Federal Tax Updates (2025)
