This article is for S Corp tier members who receive tips from customers. If you're on the LLC tier, the tip deduction may still apply to you. Tips are reported differently when there's no payroll, though, so reach out to your Collective team for guidance specific to your business.
A newer federal tax deduction lets many tipped workers keep more of what they earn. As an S Corp owner, you're both the owner of your business and its employee, so whether you can claim the deduction depends on how your tips are reported through payroll. Getting that right during the year puts you in the best position to claim it at tax time.
What the deduction is
Under current law, the "no tax on tips" deduction lets eligible workers deduct qualified tips from their taxable income for tax years 2025 through 2028. You claim it on your Individual Tax Return (ITR) using a new schedule called Schedule 1-A, and you can take it whether or not you itemize.
A few limits apply:
- The deduction is capped at $25,000 of qualified tips per year.
- It begins to phase out once your modified adjusted gross income (your total income with certain adjustments) passes $150,000, or $300,000 if you file jointly.
- It reduces federal income tax only. Your tips are still subject to Social Security and Medicare taxes.
What counts as a qualified tip
Not every tip qualifies. In most cases, a tip is qualified when all of the following are true:
- Your work is on Treasury's list of tipped occupations. The list includes more than 70 occupations in categories like food and beverage service, hospitality, personal services, personal appearance and wellness, and transportation and delivery. What matters is the work you actually do, not your job title.
- The tip was voluntary. It has to come from a customer or through a tip-sharing arrangement, like a tip pool. Mandatory service charges and automatic gratuities generally don't count unless the customer could remove or change them.
- It was paid in cash or a cash equivalent. Credit and debit cards, checks, gift cards, and payment apps all count.
Why your tips need to run through payroll
The IRS only allows the deduction for tips that show up on an official tax form, like a W-2 or 1099, or that you report yourself on your return.
Because you're an owner-employee of your S Corp, your tips belong on your W-2. If you record tips in payroll as you receive them, your W-2 will show them accurately at year end and your ITR can be prepared without extra steps. Consistent payroll records also help keep your S Corp in good standing.
If your tips weren't reported through payroll
It's common to realize after the year ends that tips weren't recorded separately. There are two ways forward, and the right one depends on your numbers:
- A corrected W-2 (Form W-2c). If the wages you've already been paid are equal to or more than your tip amount, part of those wages can be reclassified as tips on a corrected W-2. A corrected W-2 can only relabel wages you were already paid. It can't add new income on top of them.
- Reporting tips on your ITR. If your tips were more than the wages you were paid, or you'd rather not wait for a corrected W-2, the tips can be reported directly on your ITR.
Your Collective team can help you work out which option fits your situation.
Common misconceptions
"All my tips are tax free." The deduction lowers your income tax, but Social Security and Medicare taxes still apply, and the deduction is capped.
"If I get tips, I qualify." Your work has to be on Treasury's list, and the tips have to be voluntary.
"I can deduct tips I never ran through payroll." For S Corp owners, tips need to appear on your W-2 or be reported on your ITR to be eligible.
Next steps
If you receive tips and aren't sure whether your work or your tips qualify, reach out to your Collective team before you file. They're here to help you sort out the reporting so you're ready at tax time.
For more detail, see these IRS resources:
- Final regulations listing tipped occupations (IR-2026-49)
- How to take advantage of no tax on tips and overtime (Tax Tip 2026-06)
- Occupations that customarily and regularly received tips
- Schedule 1-A, Additional Deductions
- Tip recordkeeping and reporting
The information contained in this article is provided for informational purposes only and should not be construed as legal, financial, or tax advice. It is not intended to be a substitute for obtaining legal, accounting, or other financial advice from an appropriate and/or licensed adviser, or for the purpose of avoiding U.S. Federal, state or local tax payments and penalties.