How the $25,000 Tips Cap Phases Out
The IRC Section 224 tips deduction phases out at a rate of 10% of MAGI above $150,000 for single and head of household filers, or $300,000 for married filing jointly. This means the deduction is reduced by $100 for every $1,000 your MAGI exceeds the threshold. Combined with the $25,000 dollar cap, higher-income tipped workers receive a smaller (or zero) deduction.
The two limits: dollar cap and phase-out
The tips deduction has two separate limits that work together:
- Dollar cap: You can deduct no more than $25,000 of qualified tips per taxpayer per year, regardless of how much you actually earned in tips.
- MAGI phase-out: If your modified adjusted gross income exceeds the threshold for your filing status, the $25,000 cap is reduced.
Your actual deduction is the lesser of: (a) your qualified tip income, or (b) the phase-out-adjusted cap. If you earned $18,000 in tips and the phase-out reduces your cap to $20,000, you deduct only $18,000 (since that is the lesser amount).
How the phase-out calculation works
The phase-out formula from IRC Section 224 uses a "$100 per $1,000" structure, which works out to a 10% reduction rate:
- Start with your MAGI
- Subtract the threshold for your filing status:
- Single / Head of Household: $150,000
- Married Filing Jointly: $300,000
- Married Filing Separately: not eligible (no deduction at any income)
- Multiply the excess by 10%
- Subtract the result from $25,000
- Your deduction is the lesser of that result or your actual qualified tips (and cannot be below $0)
In formula form: Deduction = min(qualified tips, max(0, $25,000 - 10% x (MAGI - threshold)))
Worked examples
Example 1: Single filer, MAGI $200,000
Qualified tips: $25,000
MAGI: $200,000
Excess over threshold: $200,000 - $150,000 = $50,000
Reduction: 10% x $50,000 = $5,000
Adjusted cap: $25,000 - $5,000 = $20,000
Deduction: $20,000 (lesser of $20,000 adjusted cap or $25,000 in tips)
Example 2: MFJ couple, MAGI $350,000, one spouse tipped
Qualified tips (one spouse): $25,000
MAGI (joint): $350,000
Excess over threshold: $350,000 - $300,000 = $50,000
Reduction: 10% x $50,000 = $5,000
Adjusted cap: $25,000 - $5,000 = $20,000
Deduction: $20,000
Example 3: Single filer, MAGI $160,000, tips of $8,000
Qualified tips: $8,000
MAGI: $160,000
Excess over threshold: $160,000 - $150,000 = $10,000
Reduction: 10% x $10,000 = $1,000
Adjusted cap: $25,000 - $1,000 = $24,000
Deduction: $8,000 (lesser of $24,000 adjusted cap or $8,000 in actual tips)
When is the deduction fully eliminated?
The deduction reaches zero when the phase-out reduction equals the full $25,000 cap. Using the formula:
$25,000 = 10% x (MAGI - threshold), so MAGI = threshold + $25,000 / 10%
- Single / HoH: $150,000 + $250,000 = $400,000
- MFJ: $300,000 + $250,000 = $550,000
At or above these MAGI levels, the tips deduction is completely unavailable. Note that these thresholds are not indexed for inflation; they remain fixed for all four years the law is in effect (2025 through 2028).
Planning strategies
If your MAGI is near the phase-out range, several strategies may help preserve more of the deduction:
- Maximize pre-tax retirement contributions: Traditional 401(k) and traditional IRA contributions reduce MAGI, potentially keeping you below the $150,000 (or $300,000) threshold.
- HSA contributions: Health savings account contributions are above-the-line deductions that lower MAGI.
- Filing status review: If you are married and one spouse has significant tip income, confirm that filing jointly (with the higher $300,000 threshold) produces a better result. Remember, Married Filing Separately is not eligible for the deduction at all.
- Income timing: If you have discretionary income (e.g., a year-end bonus or capital gains), deferring it to a later year could keep your MAGI below the phase-out threshold.
Use the no tax on tips calculator to model different scenarios, or try the OBBBA phase-out calculator to see how tips, overtime, and senior bonus deductions interact with the MAGI phase-out.