What's hilarious about this is that everyone has always known that no one ever reports all of their tip income. That's why IRS gladly provides advice on what you can get away with. Against a background of "voluntary compliance," the by-the-book readers of Section 224 claim, perhaps with some justification, that it is a message to the small businessperson that "we don't trust you unless there is third-party evidence that you actually got those tips." The November election isn't going to be won by the party pursuing this attitude, so I'm sure they will chicken out.
That can be done in one of two ways. First, a technical correction in legislation later this year. Or, a Treasury interpretation that what this really means is that (1) there is a deduction for "qualified tips," and (2) if these are tips that have to be reported on a W-2 or 1099, those are the numbers you have to use.
Here is what the Tax Section of the American Bar Association had to say to Treasury about this matter, last October:
III. Self-Employed Taxpayers
A. Background
Section 224 acknowledges that self-employed taxpayers are entitled to the qualified tip income deduction and limits the deduction to the net income allocable to the trade or business in which the qualified tips are received.
Section 224 and the Proposed Regulation require that a qualified tip be included in statements furnished to the individual under sections 6041(d)(3), 6041A(e)(3), 6050W(f)(2) or 6051(a)(18) or on Form 4137. Section 6041 only requires businesses to issue Form 1099-NEC, Non-Employee Compensation, to contractors. Yet, many occupations listed in Table 1 of Prop. Treas. Reg. §1.224-1(f) customarily and regularly tipped occupations as of December 31, 2024 are those involving self-employed taxpayers who provide services to households, such as home plumbers, pet caretakers, tutors, babysitters, and hairdressers. These self-employed taxpayers will not receive Forms 1099-NEC from their customers. They may receive a form 1099-K, Payment Card and Third Party Network Transactions, if they accept payment by credit or debit card and the customer includes the tip on the charge, or if they use a third-party settlement organization (such as PayPal) and the customer transfers any tip in this manner, and such charges exceed $20,000 and over 200 transactions for the year.
B. Recommendations
Due to the mid-year enactment and retroactive application of section 224, and the fact that the Service announced36 that there will not be any changes to information return forms, we encourage the Service to provide relief to contractors who do not receive reports of their tips or other income on Forms 1099. We recommend the Service provide a safe harbor for contractors who maintain records (such as those required under section 6001) documenting an amount that would otherwise meet the definition of “qualified tips” under section 224 for 2025.
It's possible that future changes to Form 1099-K reporting thresholds will allow more self-employed taxpayers to utilize Form 1099-K to be eligible for the tip income deduction, but until that happens, we recommend the Service create a form similar to Form 4137 that can be used by self-employed taxpayers to report their tip income.
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