The One Big Beautiful Bill Act (OBBBA), also referred to as the Working Families Tax Cut Act, introduced two new federal income tax deductions in the summer of 2025. You’ve probably heard these referred to as “No Tax on Overtime” and “No Tax on Tips.” While the names are catchy, they can also be a little misleading.
These provisions do not eliminate taxes on overtime or tips altogether. Instead, they create temporary federal income tax deductions that can reduce taxable income for eligible workers.
These deductions apply retroactively to January 1, 2025, so all qualified overtime pay and/or tips earned between January 1 and December 31, 2025, can be included when calculating them. Workers claim the deductions on their 2025 federal income tax return, filed in 2026. Because of this, these changes may affect a wide range of people as they prepare their 2025 returns.
Below, we break down how these deductions work, who may qualify, and what employers should know.
The Overtime Deduction (“No Tax on Overtime”)
Non‑exempt employees may deduct up to $12,500 of qualified overtime pay from federal taxable income each year ($25,000 for joint filers).
What counts as “qualified overtime”?
Only the premium portion of overtime pay qualifies, not the entire overtime wage. So basically, the “half” part of “time-and-a-half.”
For example:
- Regular hourly rate: $25.00
- Overtime rate (time‑and‑a‑half): $37.50
- Qualified overtime portion: $12.50 per hour ($37.50 – $25.00)
Only that $12.50 premium portion is eligible for the deduction.
Note: Even when an employer pays double overtime, only the amount equivalent to time-and-a-half counts toward the deduction.
Income limits
The deduction begins to phase out (is reduced or eliminated) when income exceeds:
- $150,000 for single filers
- $300,000 for joint filers
The Tips Deduction (“No Tax on Tips”)
Workers in customarily tipped occupations may deduct up to $25,000 per year in qualified tips from federal taxable income. This deduction is per tax return, not per spouse. For example, a married couple filing jointly with $40,000 in qualified tips between them may still deduct only up to $25,000 total; the deduction cannot be doubled to $50,000 on a joint return.
Qualifying tips include:
- Tips paid voluntarily, determined by the person giving the tip
- Tips paid by cash, credit and debit card, gift cards, and other electronic payments (such as Paypal)
- Tips received through tip‑pooling or tip‑sharing arrangements
Tips that do not qualify:
- Mandatory service charges and automatically added gratuities
- Tips in the form of property, services or digital assets (cryptocurrency, etc)
- Tips from illegal activities
Expanded Access for a Limited Period
Normally, this deduction only applies to “customarily tipped” jobs, such as servers, bartenders, hairstylists, or taxi drivers, where tips make up a regular part of pay. Managers, supervisors, back-of-house staff, and most salaried professionals are usually excluded. But for 2025, the IRS is allowing more flexibility, giving some employees in borderline or under-reported situations a chance to claim it. Even so, the traditional exclusions still mostly apply, so not everyone outside those tipped roles will qualify.
Income limits
As with the overtime deduction, the tip deduction begins to phase out at:
- $150,000 for single filers
- $300,000 for joint filers
What Employers Should Know
Because many small businesses employ hourly or tipped workers, these new deductions are likely to spark questions. Even though employees claim the deductions on their individual tax returns, these rules can still affect your payroll processes, employee conversations, and year-end reporting.
As those questions start coming in, here are a few key things employers should keep in mind:
✓ No required W-2 changes for 2025. Because the IRS designated 2025 as a transition year, Form W-2 was not revised to separately report qualified overtime or qualifying tips. Employers are not required to track or label these amounts differently.
✓ Optional supplemental reporting. While not required, some employers may provide employees with a year-end summary or supplemental statement showing overtime premiums or reported tips to help employees support their deductions. Good documentation will be essential.
- Employees may use:
- Pay stubs
- Earnings statements
- Tip reports
- Employer summaries
- Independent contractors may rely on:
- Receipts
- Point-of-sale reports
- Payment processor records
- Daily tip logs
- Well-documented cash tip records
✓ Payroll taxes still apply. Overtime and tips remain subject to employer payroll taxes, including Social Security and Medicare. These deductions do not reduce employer tax obligations.
✓ State and local taxes may apply. Employees may assume these changes mean their overtime or tips are completely tax‑free. Employers should be prepared to explain that these are federal income tax deductions only and do not eliminate all taxes. Overtime and tips may also be subject to state and local taxes.
✓ Employees may want to update their W-4. If employees expect to qualify for the overtime or tip deduction, they may end up having more federal income tax withheld than necessary during the year. To avoid overpaying and waiting for a larger refund at tax time, some may choose to submit a new Form W-4 to reduce their federal withholding and increase their take-home pay now.
Note: Withholding changes must come directly from the employee. Employers cannot adjust withholding without receiving a newly completed Form W-4. It’s also a good idea to encourage employees to talk with a tax professional before making changes.
✓ Changes beginning in 2026. Forms W-2, 1099-NEC, 1099-MISC, and 1099-K will be updated for tax years 2026 through 2028 to separately report qualified overtime and tips. Beginning in 2026, only amounts reported in these designated boxes will qualify for the deduction.
✓ Documentation matters. As always, accurate time tracking, wage records, and tip reporting remain essential.
Temporary, But Impactful
Both the overtime and tip deductions are temporary and currently apply only to tax years 2025 through 2028. While limited in duration, they may provide meaningful tax savings for eligible workers during that time.
These changes may also affect payroll processes and year‑end tax planning. If you have questions about how these deductions apply to your situation, or would like help preparing for the new reporting landscape, please don’t hesitate to reach out. We’re happy to help you navigate what’s new!