Foreign Vessel Tip Risk Memo

The 2025–2028 tax law provides a limited deduction for certain “qualified tips”, up to $25,000 per year (subject to phaseouts). A qualified tip is generally defined as a cash tip received in an occupation that customarily receives tips, paid voluntarily, not part of a mandatory service charge, and properly reported on a U.S. tax form (e.g., Form W-2, Form 4137, Form 1099) or substantiated by records. Transition guidance for 2025 allows some flexibility in reporting requirements.

Certain occupations, including charter boat workers, are explicitly listed as eligible.

Tips earned while employed by a foreign employer on a foreign-flagged vessel outside the United States raise the following considerations:

1. Statutory language does not explicitly disqualify foreign tips, and transition relief in 2025 may allow deduction without a W-2.
2. However, the deduction is intended to apply to tips that can be tracked within the U.S. tip reporting system, including W-2 or 4137 reporting or equivalent substantiation.
3. Foreign-vessel tips are often:
   • Paid by a foreign employer,
   • NotreportedonW-2or4137,
   • Not part of the U.S. payroll/tip system.

While transition relief may allow some flexibility for substantiation, these tips may still fall outside the IRS’s intended scope.

Claiming the tip deduction in this scenario carries the following risks:

• IRS challenge: The IRS could argue the tips are not “otherwise qualifying” and disallow the deduction.
• Documentation requirements: You must maintain accurate substantiation of tips received, including amounts, dates, and sources, to support a deduction
• Documentation requirements: You must maintain accurate substantiation of tips received, including amounts, dates, and sources, to support a deduction

• The statute is silent regarding foreign-source tips, and transition relief may provide some flexibility for 2025.
• However, the IRS interprets the tip deduction as primarily applicable to tips that are integrated into the U.S. tip reporting system.
• Claiming the deduction for tips earned on foreign-flagged vessels outside the U.S. is therefore a risk, particularly when your employer does not issue a W-2.
• Taxpayers choosing to claim the deduction should maintain detailed records and be aware of the potential for the deduction to be disallowed.

Please sign below if you would still like to claim the tip exemption on your current year income tax return