by Tom Andrews, CPA
As some of you are already aware there will be a “tip exemption” included as part of the “One Big Beautiful Bill” for tax year 2025. Crew have already asked me if they can ask their employer to reclassify there wages as “tips”? The short answer is NO.
Under IRC § 3121(q) , Treas. Reg. § 31.3121(a)(12)-1,, and Rev Rul. 2012-18 tips are amounts that:
- Are freely given by a customer,
- Are not subject to the employer’s discretion or negotiation, and
- Are not mandatory service charges (i.e., not imposed by the employer).
Based on this language an employer or employee may not simply reclassify bonuses or wages to manipulate the tip exemption. It should also be noted that in order to receive the tip exemption you must first declare those tips as income.
What about owners that have a third-party charter relationship with their own vessel “self charter”? I’m thinking the IRS would disallow the tip exemption under these circumstances as the “economic substance” of the transaction would be scrutinized. As stated above the tip must be “given freely by a customer”.. if there is already an employer/employee relationship I doubt the exemption would be considered valid.
How Exactly Does The Tip Exemption Work?
Mechanics of the Tip Deduction
– The law allows eligible individuals (employees, and in applicable cases independent contractors) to deduct up to $25,000 in “qualified tips” from their adjusted gross income (AGI).
– The deduction is available for the first dollar of qualified tips (not just the excess above a threshold).
– The deduction phases out for taxpayers with modified adjusted gross income (MAGI) above $150,000 (single filers) and $300,000 (joint filers).
– It is explicitly an income tax deduction; it does not affect required payroll tax withholding (i.e., FICA) on tip income, which continues to apply.
– Eligible occupations must be those that, as of December 31, 2024, “customarily and regularly” receive tips. The Treasury/IRS is issuing a list of qualifying occupations.
– The deduction expires after 2028 unless extended by future legislation.
Implications for Yacht Crewmembers
1. Applicability to Crew Tip Income
Yacht crew often receive tip income (e.g. from guests, bar service, hospitality). If your role is among those designated as “customarily tipped,” your tip income may qualify. However, the Treasury list initially emphasizes more traditional service industries (restaurants, hotels, salons, etc.).
- Limitation and Phase‑Out
The $25,000 cap means that high-tipping crewmembers will only benefit up to that limit. Above the deduction cap, tip income remains fully taxable. Also, high total income may phase out eligibility entirely.3. Nonresident Alien / U.S. Source Income Considerations
Because many nonresident crewmembers file Form 1040‑NR, they are not generally eligible to claim above‑the‑line deductions available to U.S. residents unless a treaty or special rule applies. The new tip deduction is drafted for U.S. taxpayers with Social Security Numbers. Thus, nonresident crewmembers may not benefit unless legislative or regulatory clarifications expressly permit it.4. Recordkeeping and Reporting
To substantiate the deduction, crewmembers must maintain detailed records of tip amounts, allocation, and job classification. Employers/payroll agents must report tip income on W‑2s (or equivalent statements) and designate qualified tip amounts.5. Withholding and Refund Dynamics
Employers cannot reduce withholding at pay time because of this deduction. The taxpayer claims the deduction when filing, which may yield a refund or reduced tax liability.
Summary
The Big Beautiful Bill’s tip deduction provides a new tool to reduce income tax on tip income, capped at $25,000 with phase‑out starting at $150,000 (single) / $300,000 (joint). However, its current drafting suggests it is intended for U.S. taxpayers with Social Security Numbers, raising doubts about its applicability to nonresident crewmembers filing 1040‑NR. Yacht crew should monitor regulatory guidance and Treasury rulings to see whether their tip‑income roles will be recognized.
PLEASE NOTE THAT AS OF THE WRITING OF THIS COLUMN WE ARE STILL WAITING ON FINAL IRS REGARDING THE TIP EXCLUSION. SUBJECT MATTER MAY CHANGE AFTER IRS GUIDANCE IS ISSUED.
Disclaimer: The information provided in this column is for general educational purposes only and does not constitute tax, legal, or accounting advice. Readers should consult a qualified tax professional or advisor regarding their specific circumstances, especially when applying the foreign earned income exclusion or determining bona fide residence status under U.S. tax law.