& Kelsey Eure | Senior
If you are a working individual who earns tips or receives overtime pay, you could be eligible for meaningful tax relief. The recently passed One Big Beautiful Bill Act (OBBBA) includes two temporary provisions —No Tax on Tips and No Tax on Overtime—available to taxpayers who itemize deductions or use the standard deduction for tax years 2025-2028.
But what requirements and actions do employers and employees need to consider in order to receive the full benefits of these deductions? In this article, we’ll explore how the No Tax on Tips and No Tax on Overtime deductions work, who qualifies, and what steps are needed to take full advantage of the benefits.
No Tax on Tips
The No Tax on Tips provision of the OBBBA allows qualified employees to deduct up to $25,000 of qualified tips from their federal taxable income. However, this exception does have a phase-out based on total earnings. The phase-out begins at modified adjusted gross income of $150,000 for individuals and $300,000 for couples, where $100 is deducted per $1,000 over the threshold.
Deduction Requirements
Several requirements must be met for the tips to qualify for the deduction. It is important to note that all tips must be reported to the employer and any under-the-table tips or physical gifts represented as tips will not qualify. Further guidance will be provided later in the year to extend the types of tips that can be reported (i.e., Venmo transactions, Wire transactions, etc.). The following rules are currently in effect:
- All qualified tips must be reported on the employees’ W-2s, 1099s or on Form 4137. These tips include tips directly given to the employee, as well as the employee’s share of tip pools or shared tips. If these tips are not reflected on these government forms, they will not be eligible.
- The tips must be voluntary at the customer’s discretion. Qualified tips do not include items such as mandatory service charges or required gratuities for large parties.
- The tips must be earned in a qualified occupation that regularly received tips on or before December 31, 2024. Such occupations include: food services, hospitality and personal care. Occupations considered to be a specified service trade or business such as accounting, law and health services are specifically excluded from eligibility for the No Tax on Tips deduction. The IRS will release an update later this year of a full list of occupations that will qualify for the No Tax on Tips deduction in 2025.
What Employers Need to Do
To ensure no mistakes are made in the future, employers should think about these key items:
- Payroll systems should be updated to track qualified and non-qualified tips.
- Previous payrolls in 2025 should be reviewed and updated to account for qualified and non-qualified tips.
What Employees Need to Do
Employees should keep the following key items in mind when evaluating their eligibility for the deduction:
- If a taxpayer is married, they must file jointly to qualify for this deduction.
- Starting in 2025, double-check W-2s and 1099s and keep a personal record to make sure all tips are properly being reported.
- Review your federal withholdings and consider adjusting for the potential reduction in taxes.
- This is a federal law; state and local taxes may still be in effect for tip income unless state and local laws are passed to mimic the OBBBA.
No Tax on Overtime
The No Tax on Overtime provision allows employees to take a deduction of their overtime compensation that exceeds their regular pay rate. So, if an employee earns time-and-a-half for overtime, the “half” portion (the bonus above their standard wage) is eligible for deduction, with a max deduction of $12,500 ($25,000 for joint filers) per year. This deduction begins to phase-out at $150,000 for individuals and $300,000 for couples, where $100 is deducted per $1,000 over the threshold.
Deduction Requirements
There are some qualifications that the overtime pay needs to meet to qualify for the deduction:
- Overtime employees must be “non-exempt” under the Fair Labor Standards Act (FLSA). These are employees who are required to have overtime pay after they have worked over 40 hours per week.
- Overtime compensation rates generally must meet the federal standards of 1.5 times the regular hourly wage. If the overtime rate is less than the federal standard, the overtime pay will not qualify for the deduction.
- All overtime must be properly reported on W-2s and payroll reports.
Similar to the No Tax on Tips deduction, the items below are matters that employees and employers should keep in mind when thinking about the No Tax on Overtime deduction:
What Employers Need to Do
To ensure no mistakes are made in future reporting, employers should:
- Make sure the payroll software in use can separately track overtime.
- Make sure all overtime is reported correctly on employee W-2s
What Employees Need to Do:
Employees should keep the following items in mind when evaluating their eligibility for the deduction:
- Separately track overtime and double-check compared to issued W-2s and payroll reports.
- This is a federal law; state and local taxes may still be in effect for tip income unless state and local laws are passed to mimic the OBBA.
Need Help Navigating These Changes?
Our team is closely monitoring the new tax guidance to keep individuals informed about the latest changes and updates. Throughout the rest of 2025, the IRS will be releasing more details and information about topics such as:
- Tip and overtime qualification statuses of more nuanced employees like independent contractors & union workers.
- How employers should properly record tips and overtime.
- Transition relief for tax year 2025.
- New W-2 fields to report tips and overtime income.
Contact our team today if you have any questions on the above requirements or want to discuss how these tax law changes impact you.
