Overview: Temporary Federal Tax Deductions for Tips and Overtime
The One Big Beautiful Bill Act (OBBBA) introduced two new temporary federal income tax deductions designed to reduce taxable income from tips and overtime. These provisions apply from 2025 through 2028. While these changes may sound like “no tax on tips” or “no tax on overtime,” they’re actually limited deductions—not exclusions. Federal payroll taxes still apply.
Tip Income Deduction (2025–2028)
Workers can deduct up to $25,000 per year in qualified tip income. The deduction begins to phase out once Modified Adjusted Gross Income (MAGI) exceeds $150,000 for single filers and $300,000 for married joint filers.
Key details:
- Available to employees and self-employed workers in IRS-designated “tipped” occupations.
- Occupations may include surprising roles such as plumbers, HVAC technicians, digital content creators, electricians, and movers.
- Excludes certain industries like healthcare, law, accounting, finance, and investment management.
- Qualified tips include cash, credit card payments, and tip-sharing arrangements.
- Deduction is available whether or not the worker itemizes deductions.
Overtime Income Deduction (2025–2028)
Workers can also deduct up to $12,500 annually in qualified overtime income or $25,000 for married joint filers. The same MAGI phaseouts apply.
Important distinctions:
- Applies only to overtime mandated by Section 7 of the Fair Labor Standards Act (FLSA) (time-and-a-half pay).
- Only the “extra half” of overtime pay counts as qualified overtime income.
- Excludes overtime premiums required by state laws or union contracts.
- Overtime deduction does not apply to tip income.
Payroll Tax Implications: Still Taxable for FICA and Withholding
Although these deductions reduce federal taxable income, they do not exempt tip or overtime wages from federal payroll taxes (Social Security and Medicare). Employers must continue to withhold applicable federal taxes and may also need to comply with state and local income tax rules, which can still treat tips and overtime as fully taxable.
Reporting Requirements for Employers and Payroll Firms
To help employees claim these deductions, employers and payroll providers must track and report qualified income accurately:
- Tip Income: Report on Form W-2, Form 1099-NEC, or another specified information return furnished to both the worker and the IRS.
- Overtime Income: Report on Form W-2 or another specified information return furnished to both the worker and the IRS.
IRS Guidance on Forms and Withholding Tables
For tax year 2025, the IRS has confirmed there will be no immediate changes to W-2s, 1099s, Form 941, or federal income tax withholding tables to account for OBBBA deductions. This decision gives businesses, payroll firms, and tax professionals time to prepare for updates in tax year 2026.
Action Steps for Employers
Employers and payroll firms should:
- Begin tracking qualified tip and overtime income immediately.
- Implement procedures to retroactively track income paid before July 4, 2025 (when OBBBA became law).
- Watch for IRS updates and transition relief for tax year 2025.
Need help navigating these new tax rules? Contact our team today to ensure your business stays compliant and your employees receive their full tax benefits.