Under the One Big Beautiful Bill signed by President Trump in 2025, qualifying tipped workers can deduct up to $25,000 of tip income from their federal taxable income each year through 2028.1The White House. The One Big Beautiful Bill But “no tax on tips” in Arizona is only a partial break. The deduction touches federal income tax only. Social Security, Medicare, and Arizona’s 2.5% state income tax still apply to every dollar of tips you earn, and the way the federal deduction is written means it does not automatically lower your Arizona bill at all.
How the Federal Tip Deduction Works
The No Tax on Tips Act passed the Senate unanimously in May 2025 and was folded into the reconciliation bill. It creates a below-the-line federal deduction for qualified tip income.2Congress.gov. S.129 – No Tax on Tips Act 119th Congress (2025-2026) Below-the-line matters here: the deduction reduces your federal taxable income, but it does not reduce your adjusted gross income. That single detail is what keeps Arizona’s tax on your tips intact, as covered further down.
Three conditions must be met to claim the deduction:
- You work in an occupation that customarily and regularly receives tips.
- The tips are cash tips, including credit and debit card tips, reported to your employer for payroll tax purposes. Non-cash tips like gift cards or event tickets do not qualify.
- Your total compensation in the prior tax year did not exceed $160,000 (2025 threshold, adjusted annually for inflation).2Congress.gov. S.129 – No Tax on Tips Act 119th Congress (2025-2026)
The cap is $25,000 per year. Earn $35,000 in tips during 2025, and you can deduct $25,000; the remaining $10,000 is still subject to federal income tax at your normal rate. The provision is retroactive to January 2025, so workers who already filed their 2025 federal return may need to file an amended return or follow IRS guidance for claiming the deduction after the fact.3Internal Revenue Service. How to Take Advantage of No Tax on Tips and Overtime
The deduction sunsets after tax year 2028. Unless Congress renews it, tips will be fully federally taxable again starting with the 2029 tax year.
What the Deduction Does Not Cover
The label is doing a lot of work. Tips are not tax-free. The deduction shields tip income from federal income tax and nothing else.
Social Security tax still takes 6.2% of your wages and tips up to $184,500 in 2026. Medicare takes another 1.45%, with no wage cap, and an additional 0.9% Medicare surtax kicks in above $200,000.4Internal Revenue Service. Social Security and Medicare Withholding Rates Your employer withholds these from every paycheck regardless of the deduction. For a server earning $40,000 in combined wages and tips, FICA alone still claims more than $3,000.
Arizona income tax also still applies to your tips. Arizona uses your federal adjusted gross income as the starting point for its own return.5Arizona Department of Revenue. Arizona Form 2025 Resident Personal Income Tax Return 140 Because the federal tip deduction sits below the AGI line, your tips flow into Arizona’s calculation at the full amount. Nothing about claiming the federal deduction reduces what you owe the state.
Arizona’s Tax on Tip Income
Arizona applies a flat 2.5% income tax to all individual income.6Arizona Department of Revenue. Individual Income Tax Highlights The state calculates your tax from federal AGI, then applies Arizona-specific additions and subtractions.7Arizona Department of Revenue. Arizona Individual Income Tax Ruling ITR 93-6 Every dollar of reported tips is part of that base.
The state legislature has looked at changing this. HB 2081, sponsored by Representative Gail Griffin, would exempt tips from Arizona’s personal income tax. The bill advanced from the House Ways and Means Committee in January 2025.8Arizona Legislature. No Tax on Tips Advances House Committee – HB2081 Until it becomes law, plan on paying the 2.5% on all your tip income.
Skipping the state tax on tips is not a workable strategy. Late filing or underpayment triggers penalties under A.R.S. 42-1125: 4.5% of the unpaid tax for each month the return is late, capped at 25%.9Arizona Legislature. Arizona Code 42-1125 – Civil Penalties; Definition Intentionally omitting tip income can lead to audits and criminal tax evasion charges on top of that, and interest runs on any unpaid balance.
Reporting Your Tips Correctly
The federal deduction only applies to cash tips reported to your employer for payroll tax purposes, so your reporting habits decide whether the deduction is available in the first place.
If you receive $20 or more in tips during any calendar month, you must report the total to your employer by the 10th day of the following month.10Internal Revenue Service. Topic No. 761, Tips – Withholding and Reporting Your employer uses those figures to withhold income tax and FICA, and at year-end the reported total appears on your W-2 alongside your wages.
Keep a daily log of every tip: cash, card additions, and your share of any tip pool. The IRS offers Form 4070 for this, but any log with date, amount, and source is fine.11Internal Revenue Service. Form 4070 – Employee’s Report of Tips to Employer Arizona requires you to keep tax records for at least four years from the return’s due date or filing date, whichever is later.12Arizona Department of Revenue. Record Keeping If the state or the IRS ever imputes a higher income than you actually earned, that log is your defense.
Non-cash tips like event tickets or gift certificates are handled differently. You don’t report them to your employer, but you must include their fair market value on your tax return.13Internal Revenue Service. Tip Recordkeeping and Reporting They also do not qualify for the new federal deduction, which means they are fully taxable at both the federal and state level.
Filing Your Arizona Return
Arizona Form 140 is the resident personal income tax return. Line 12 is where you enter your federal adjusted gross income, which already includes your reported tips from your federal return.5Arizona Department of Revenue. Arizona Form 2025 Resident Personal Income Tax Return 140 Make that number match your W-2 and federal return exactly. A mismatch between what your employer reported and what you enter is one of the fastest ways to trigger a review.
You can file electronically through the Arizona Department of Revenue’s e-file system, which routes returns through the IRS before sending them to the state.14Arizona Department of Revenue. Free Electronic Filing for Individuals As of mid-2026, electronic returns were processing in about six days versus roughly 20 days for paper.15Arizona Department of Revenue. Check Refund Status
One trap for tipped workers: withholding often does not keep up with actual tax owed, because a large share of income comes from cash tips that are reported after the fact rather than withheld against in real time. If you expect to owe at least $1,000 in federal tax after withholding and credits, you may need to make quarterly estimated payments using Form 1040-ES.16Internal Revenue Service. Estimated Tax for Individuals The federal tip deduction reduces what you eventually owe, but it does not change the underwithholding problem during the year. Setting money aside from each shift is still the safest way to avoid a surprise at filing time.