No Tax on Tips Arizona 2026: Federal + State Subtraction Explained

Arizona Tipped Workers Get a Real State-Level Tax Break in 2026

Unlike many states that simply leave the federal One Big Beautiful Bill Act (OBBBA) tips deduction alone, Arizona passed its own matching state subtraction. House Bill 4168 — a tax omnibus bill signed by Governor Katie Hobbs on June 13, 2026 — creates an Arizona individual income tax subtraction equal to the amount of qualified tip income you deduct on your federal return under Internal Revenue Code §224 (the OBBBA tips provision). The subtraction applies retroactively to tax years beginning January 1, 2025, with the broader HB 4168 package taking effect July 1, 2026.

Because Arizona taxes income at a single flat 2.5% rate rather than progressive brackets, the mechanics are simpler than in most states: whatever tip income you exclude federally under the $25,000 cap is also excluded from your Arizona taxable income, saving you 2.5% of that amount on top of your federal savings. This guide walks through exactly how the federal deduction works, how Arizona's mirrored subtraction is calculated, what still gets taxed (FICA, and any tips above the cap), and three worked dollar examples.

What HB 4168 Actually Did

Before June 2026, Arizona had not conformed to the federal OBBBA tips provision. Earlier attempts to pass a matching state break — including SB 1106 and an earlier version of HB 2785 — were vetoed by Governor Hobbs as part of broader disputes over corporate tax cuts bundled into the same bills. The tips and overtime subtractions only became law once they were folded into the final bipartisan budget package.

House Bill 4168 ("taxation; omnibus; 2026–2027") is the bill that ultimately passed and was signed. It rewrote large sections of Arizona's Title 43 income tax code to align with the federal OBBBA. Among its provisions, HB 4168 creates a subtraction from Arizona gross income equal to "the amount of qualified tips received during the taxable year that is deducted under" the federal qualified-tips deduction (IRC §224). In plain terms: whatever dollar figure you claim as your federal tips deduction on Schedule 1 of Form 1040, you also get to subtract that same figure from your Arizona taxable income.

This is a genuine, enacted law — not a proposal. It applies to tax years beginning January 1, 2025, meaning it was available for the 2025 tax year return filed in 2026, and remains available for tax year 2026. The Arizona Department of Revenue (ADOR) has published a Middle Class Tax Cuts Package (MCTCP) worksheet to help filers calculate the subtraction; check azdor.gov for the current version before filing, since ADOR guidance issued before the bill's enactment treated this subtraction as optional and has since been updated to reflect that it is mandatory.

How the Federal OBBBA Tips Deduction Works

The federal starting point is the same for every state. The OBBBA created an above-the-line deduction — not a full exemption — of up to $25,000 in qualified tip income per year:

• Type: An income deduction claimed on Schedule 1 of Form 1040. It reduces your federal Adjusted Gross Income (AGI); it is not a tax credit and does not reduce your bill dollar-for-dollar.
• Cap: $25,000 of qualified tips, regardless of filing status.
• Phase-out: Begins at $150,000 AGI for single filers and $300,000 AGI for married filing jointly, reducing dollar-for-dollar until fully eliminated.
• Qualifying occupations: Jobs where tipping was customary before 2025 — servers, bartenders, hotel staff, hairstylists, valets, delivery drivers, and similar roles.
• FICA is untouched: Social Security and Medicare still apply to every dollar of tip income.
• Sunset: Expires December 31, 2028 unless Congress extends it.

Most Arizona servers and bartenders earn well under the $150,000 phase-out threshold and can claim the full $25,000 federal deduction. For the complete federal mechanics, see the OBBBA Tips Deduction Explainer.

How Arizona's Subtraction Stacks on Top

Arizona's income tax return starts from your federal AGI and then applies state-specific additions and subtractions. Because the OBBBA tips deduction already reduced your federal AGI before it reaches your Arizona return, Arizona's HB 4168 subtraction restores the benefit at the state level rather than clawing it back — the opposite of what non-conforming states like California and New York do.

Concretely: if you claimed a $20,000 federal tips deduction, your Arizona return also allows a $20,000 subtraction from Arizona gross income. At Arizona's flat 2.5% rate, that $20,000 subtraction is worth $500 in Arizona income tax savings ($20,000 × 2.5%) — on top of whatever you saved federally.

Because Arizona uses one flat rate instead of brackets, the math is simple: Arizona tax saving = subtraction amount × 2.5%. There's no need to work out marginal brackets like in states with progressive income tax. The trade-off is that Arizona's flat rate is already quite low, so the dollar value of the state-level saving is modest compared to the federal deduction — but it's real money that Arizona chose to give back rather than tax.

FICA and Tips Above the Cap

Neither the federal deduction nor Arizona's mirrored subtraction changes anything about payroll tax. Every Arizona tipped worker still owes FICA on 100% of reported tip income:

• Social Security: 6.2% on combined wages and tips, up to the 2026 wage base.
• Medicare: 1.45% on all wages and tips, no cap (plus an additional 0.9% surtax above $200,000 for single filers).

On $30,000 of tips, FICA alone is $30,000 × 7.65% = $2,295 — owed regardless of either deduction.

Tips above the $25,000 federal cap are also fully taxable at both the federal and Arizona level, since Arizona's subtraction only mirrors whatever amount was federally deductible. A worker earning $40,000 in tips can deduct/subtract $25,000; the remaining $15,000 is ordinary taxable income for both federal and Arizona purposes.

Worked Example: $35,000 Tips + $10,000 Wages, Single Filer

Scenario: single Arizona server, $10,000 in base wages + $35,000 in tip income = $45,000 gross income. AGI is well under the $150,000 phase-out, so the full deduction applies.

Figures exclude the Arizona standard deduction ($15,750 single for 2026), which would further reduce Arizona taxable income and tax owed. This is a simplified illustration of the subtraction mechanic, not a complete return. Always verify your exact figures with the ADOR MCTCP worksheet or a tax professional.

Worked Example: $50,000 Tips, Above the Federal Cap

Scenario: single Arizona bartender earning $50,000 in tip income for the year, no significant wage income.

This example shows that Arizona's subtraction is capped at the same dollar figure as the federal deduction — it does not extend relief beyond the $25,000 the IRS allows. High-tip earners above roughly $25,000–$30,000 in annual tips will still owe both federal and Arizona tax on the excess.