Starting with the 2025 tax year, the One Big Beautiful Bill Act (signed into law in July 2025) introduces major changes affecting how many workers report tips and overtime on their federal tax return in the U.S. Under this law, workers may be eligible for new deductions that effectively reduce taxable income for certain portions of tips and overtime compensation.
These provisions are especially important for employees in service industries (like restaurants, hospitality, and personal services) and others who earn overtime pay. The deduction rules are effective through 2028 unless extended by Congress.
How the “No Tax on Tips” Deduction Works
Under the new law, workers who receive qualified tips can claim a deduction on their federal tax return that reduces taxable income.
What Counts as Qualified Tips?
- Qualified tips are voluntary cash or card tips received from customers. They must be reported to employers or the IRS.
- The deduction mostly applies to occupations that customarily and regularly receive tips (restaurants, personal services, etc.).
- Automatic service charges and mandatory gratuities do not qualify as tips for this deduction.
Deduction Limits and Eligibility
- Individuals can deduct up to $25,000 of qualified tip income annually.
- For those married filing jointly, the maximum deduction is also $25,000.
- The deduction begins to phase out for taxpayers with modified adjusted gross income (MAGI) above $150,000 ($300,000 joint).
- Both taxpayers who itemize and those who do not itemize can claim this deduction.
This tax break effectively removes these qualified tip amounts from taxable income — meaning workers aren’t taxed on this portion of their earnings.
Understanding the “No Tax on Overtime” Deduction
The One Big Beautiful Bill Act also introduced a similar deduction for certain overtime pay.
What Is Qualified Overtime Pay?
- Qualified overtime pay refers to the premium portion of overtime — for example, the extra “half-time” pay above your regular rate for hours worked beyond the standard workweek.
- This deduction applies if the overtime compensation is reported on Form W-2, 1099, or other specified statements.
Deduction Amounts and Limits
- Single taxpayers may deduct up to $12,500 of qualified overtime compensation per year.
- Married couples filing jointly have a higher limit of up to $25,000.
- Like the tips deduction, the overtime deduction phases out at higher MAGI levels (over $150,000 for individuals, $300,000 joint).
- Eligible workers can claim this even if they do not itemize deductions.
This change can meaningfully reduce taxable income for workers who earn substantial overtime, making more of that extra pay stay in workers’ pockets.
Important Things Workers Should Know Before Filing
Record Keeping Is Key
For tax year 2025 (returns filed in 2026), employers may not be required to separately break out qualified overtime and tips on pay statements or IRS forms. Workers should therefore:
- Keep personal records of tip income and overtime earnings throughout the year.
- Save pay stubs and logs showing amounts.
Starting with later tax years, employers will increasingly provide clearer reporting on Forms W-2 or 1099 to support these deductions.
Who Can Benefit Most From These Deductions?
This tax change is designed to help:
- Workers in industries where tips are a large part of income (servers, bartenders, stylists, etc.).
- Employees with regular overtime pay who want to reduce taxable income.
- Both W-2 employees and self-employed workers, within the rules for reporting income.
However, high-income taxpayers may see the deductions diminish due to the income phase-out limits.
Conclusion: What to Do Now
If you earn tips or overtime pay, this new law creates significant opportunities to reduce your federal tax burden — but only if you claim the deduction when you file.
Action steps for workers:
- Track all tip income and overtime earnings carefully throughout the year.
- Understand your filing status and income level to see how phase-outs apply.
- Stay updated on IRS guidance as new forms and reporting requirements roll out for 2026 and beyond.
By understanding how these deductions work, you can make smarter decisions before tax season and potentially increase your take-home pay.
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