New Tax Breaks for Tips and Overtime: What Employers and Workers Need to Know for 2025
By Eddy Team — July 11, 2025
What's this about?
On July 4 2025, President Donald Trump signed H.R. 1, the One Big Beautiful Bill Act (OBBBA), into law. The statute adds two temporary above-the-line deductions:
- Up to $25,000 of qualified tip income per filer may be deducted from federal taxable wages each year.
- Up to $12,500 of qualified overtime compensation per filer may be deducted annually.
Both deductions apply for tax years 2025-2028, phase out for individuals with modified AGI above $150,000 ($300,000 joint), and do not reduce FICA taxes withheld during the year. Instead, employees claim them when filing Form 1040, potentially boosting refunds if too much tax was withheld.
A High-Level Snapshot
The OBBBA is a 900-page reconciliation package merging permanent extensions of the 2017 Tax Cuts and Jobs Act with new worker-focused deductions, while also enacting deep cuts to Medicaid and expanding border-security spending. Amid polarizing provisions, Congress bundled the No Tax on Tips and No Tax on Overtime deductions as bipartisan sweeteners.
How the Tip Deduction Works
Starting with the 2025 tax year, workers who earn tips—such as restaurant servers or hair stylists—can subtract up to $25,000 of those tips from the income the IRS taxes. The tips must be real, voluntary gifts from customers, and workers still need to report them to their employer.
Paychecks will not change during the year because normal payroll taxes still come out. Instead, when workers file their tax return the next spring, they list their tip total, and the IRS lowers the income used to figure their tax, which can mean a bigger refund. This break begins to shrink once someone makes more than $150,000 a year (or $300,000 for married couples). The rule lasts through 2028 unless Congress renews it, and it does not affect state income taxes.
How the Overtime Deduction Works
Starting with the 2025 tax year, workers can subtract up to $12,500 of overtime pay from the income the IRS taxes each year (or $25,000 for married couples filing together). The overtime must be the extra money earned for working more than 40 hours per week at time-and-a-half pay, as required by federal labor laws.
Like the tip deduction, paychecks stay the same during the year because normal taxes still come out of each paycheck. When workers file their tax return the next spring, they can list their overtime total, and the IRS lowers the income used to calculate their tax, which often means a bigger refund.
This benefit starts to shrink once someone makes more than $150,000 a year (or $300,000 for married couples), and it goes away completely at higher income levels. The rule lasts through 2028 unless Congress extends it, and it does not change state income taxes.
Worked Example—Tip Deduction
Assume Mia, a restaurant server, reports $24,000 tips, $38,000 base wages, AGI $160,500.
- Initial Deduction: $24,000 (below $25,000 cap).
- Phase-Out: AGI exceeds threshold by $10,500 ⇒ 10.5×100=$1,050.
- Final Allowed Deduction: $24,000 – $1,050 = $22,950.
- Tax Saving: At 22% marginal rate, refund increase ≈ $5,049.
W-2 & 1099 Reporting: What Changes Now?
When reporting 2025 tip and overtime deductions, employers must include two new data points on employees’ federal tax forms even though paystubs themselves aren’t mandated to show them. On Form W-2, Box 12 will now carry Code “TT” to reflect an employee’s total qualified tips for the year and Code “OT” to reflect qualified overtime pay, while Boxes 1, 3, and 5 continue to show full taxable wages (including tips and overtime) for withholding purposes.
Similarly, contractors who qualify will see their deductible tips on Box 7 of Form 1099-NEC with an overlay code “TT,” and deductible overtime pay on Box 3 of Form 1099-MISC with code “OT.” These additions ensure that year-end filings capture the separate amounts eligible for deduction, even though ordinary paystubs may simply continue to show combined tip and overtime earnings under existing wage lines.
Summary
Above all, recognize that the No Tax on Tips and No Tax on Overtime provisions are deductions, not exemptions. Payroll checks won’t balloon overnight, but well-informed planning can ensure every eligible dollar of refund lands where it belongs—boosting employee satisfaction and reinforcing your brand as a compliance-first employer.
Employers who move swiftly will avoid penalties, build trust, and potentially wield these deductions as competitive differentiators in a tight labor market. Act now, stay vigilant through 2028, and turn legislative change into strategic advantage
Frequently Asked Questions
Do these new deductions mean my paycheck will be bigger during the year?
No. Regular paychecks will not change because employers still withhold federal income tax, Social Security, and Medicare taxes based on your full wages, including tips and overtime. The benefit comes when you file your tax return and claim the deduction, which can lead to a larger refund.
No. Regular paychecks will not change because employers still withhold federal income tax, Social Security, and Medicare taxes based on your full wages, including tips and overtime. The benefit comes when you file your tax return and claim the deduction, which can lead to a larger refund.
What counts as a “qualified tip” for the new deduction?
Qualified tips are voluntary, customer-determined tips (including cash, credit card, or pooled tips) earned in jobs listed by the Treasury as “traditionally tipped occupations.” Mandatory service charges or auto-gratuities do not count as qualified tips.
Qualified tips are voluntary, customer-determined tips (including cash, credit card, or pooled tips) earned in jobs listed by the Treasury as “traditionally tipped occupations.” Mandatory service charges or auto-gratuities do not count as qualified tips.
How do I know how much of my tips or overtime are “qualified” and deductible?
Employers are required to track and report qualified tips and overtime separately for tax reporting. For 2025 and beyond, your Form W-2 will show your total qualified tips (Box 12, Code “TT”) and qualified overtime pay (Box 12, Code “OT”). While it’s not federally required to show this on your paystub, many payroll systems will add these fields for clarity.
Employers are required to track and report qualified tips and overtime separately for tax reporting. For 2025 and beyond, your Form W-2 will show your total qualified tips (Box 12, Code “TT”) and qualified overtime pay (Box 12, Code “OT”). While it’s not federally required to show this on your paystub, many payroll systems will add these fields for clarity.
Does this deduction affect Social Security or Medicare taxes?
No. The deduction only reduces federal taxable income when you file your tax return; it does not lower Social Security or Medicare taxes, which are still calculated on your full wages, including all tips and overtime.
No. The deduction only reduces federal taxable income when you file your tax return; it does not lower Social Security or Medicare taxes, which are still calculated on your full wages, including all tips and overtime.
Are there income limits for claiming these deductions?
Yes. The deductions begin to phase out once your adjusted gross income exceeds $150,000 (or $300,000 for married couples filing jointly). For every $1,000 over the limit, the deduction is reduced by $100 until it is fully phased out.
Yes. The deductions begin to phase out once your adjusted gross income exceeds $150,000 (or $300,000 for married couples filing jointly). For every $1,000 over the limit, the deduction is reduced by $100 until it is fully phased out.
Will this deduction apply to my state income taxes?
No. These new deductions only apply to federal income tax. State income taxes are not affected unless your state specifically adopts similar rules.
No. These new deductions only apply to federal income tax. State income taxes are not affected unless your state specifically adopts similar rules.
How long will these deductions be available?
The deductions are available for tax years 2025 through 2028. Unless Congress extends the law, the provisions will expire after the 2028 tax year.
The deductions are available for tax years 2025 through 2028. Unless Congress extends the law, the provisions will expire after the 2028 tax year.
New Tax Breaks for Tips and Overtime: What Employers and Workers Need to Know for 2025
By Eddy Team — July 11, 2025
What's this about?
On July 4 2025, President Donald Trump signed H.R. 1, the One Big Beautiful Bill Act (OBBBA), into law. The statute adds two temporary above-the-line deductions:
- Up to $25,000 of qualified tip income per filer may be deducted from federal taxable wages each year.
- Up to $12,500 of qualified overtime compensation per filer may be deducted annually.
Both deductions apply for tax years 2025-2028, phase out for individuals with modified AGI above $150,000 ($300,000 joint), and do not reduce FICA taxes withheld during the year. Instead, employees claim them when filing Form 1040, potentially boosting refunds if too much tax was withheld.
A High-Level Snapshot
The OBBBA is a 900-page reconciliation package merging permanent extensions of the 2017 Tax Cuts and Jobs Act with new worker-focused deductions, while also enacting deep cuts to Medicaid and expanding border-security spending. Amid polarizing provisions, Congress bundled the No Tax on Tips and No Tax on Overtime deductions as bipartisan sweeteners.
How the Tip Deduction Works
Starting with the 2025 tax year, workers who earn tips—such as restaurant servers or hair stylists—can subtract up to $25,000 of those tips from the income the IRS taxes. The tips must be real, voluntary gifts from customers, and workers still need to report them to their employer.
Paychecks will not change during the year because normal payroll taxes still come out. Instead, when workers file their tax return the next spring, they list their tip total, and the IRS lowers the income used to figure their tax, which can mean a bigger refund. This break begins to shrink once someone makes more than $150,000 a year (or $300,000 for married couples). The rule lasts through 2028 unless Congress renews it, and it does not affect state income taxes.
How the Overtime Deduction Works
Starting with the 2025 tax year, workers can subtract up to $12,500 of overtime pay from the income the IRS taxes each year (or $25,000 for married couples filing together). The overtime must be the extra money earned for working more than 40 hours per week at time-and-a-half pay, as required by federal labor laws.
Like the tip deduction, paychecks stay the same during the year because normal taxes still come out of each paycheck. When workers file their tax return the next spring, they can list their overtime total, and the IRS lowers the income used to calculate their tax, which often means a bigger refund.
This benefit starts to shrink once someone makes more than $150,000 a year (or $300,000 for married couples), and it goes away completely at higher income levels. The rule lasts through 2028 unless Congress extends it, and it does not change state income taxes.
Worked Example—Tip Deduction
Assume Mia, a restaurant server, reports $24,000 tips, $38,000 base wages, AGI $160,500.
- Initial Deduction: $24,000 (below $25,000 cap).
- Phase-Out: AGI exceeds threshold by $10,500 ⇒ 10.5×100=$1,050.
- Final Allowed Deduction: $24,000 – $1,050 = $22,950.
- Tax Saving: At 22% marginal rate, refund increase ≈ $5,049.
W-2 & 1099 Reporting: What Changes Now?
When reporting 2025 tip and overtime deductions, employers must include two new data points on employees’ federal tax forms even though paystubs themselves aren’t mandated to show them. On Form W-2, Box 12 will now carry Code “TT” to reflect an employee’s total qualified tips for the year and Code “OT” to reflect qualified overtime pay, while Boxes 1, 3, and 5 continue to show full taxable wages (including tips and overtime) for withholding purposes.
Similarly, contractors who qualify will see their deductible tips on Box 7 of Form 1099-NEC with an overlay code “TT,” and deductible overtime pay on Box 3 of Form 1099-MISC with code “OT.” These additions ensure that year-end filings capture the separate amounts eligible for deduction, even though ordinary paystubs may simply continue to show combined tip and overtime earnings under existing wage lines.
Summary
Above all, recognize that the No Tax on Tips and No Tax on Overtime provisions are deductions, not exemptions. Payroll checks won’t balloon overnight, but well-informed planning can ensure every eligible dollar of refund lands where it belongs—boosting employee satisfaction and reinforcing your brand as a compliance-first employer.
Employers who move swiftly will avoid penalties, build trust, and potentially wield these deductions as competitive differentiators in a tight labor market. Act now, stay vigilant through 2028, and turn legislative change into strategic advantage
Frequently Asked Questions
Do these new deductions mean my paycheck will be bigger during the year?
No. Regular paychecks will not change because employers still withhold federal income tax, Social Security, and Medicare taxes based on your full wages, including tips and overtime. The benefit comes when you file your tax return and claim the deduction, which can lead to a larger refund.
No. Regular paychecks will not change because employers still withhold federal income tax, Social Security, and Medicare taxes based on your full wages, including tips and overtime. The benefit comes when you file your tax return and claim the deduction, which can lead to a larger refund.
What counts as a “qualified tip” for the new deduction?
Qualified tips are voluntary, customer-determined tips (including cash, credit card, or pooled tips) earned in jobs listed by the Treasury as “traditionally tipped occupations.” Mandatory service charges or auto-gratuities do not count as qualified tips.
Qualified tips are voluntary, customer-determined tips (including cash, credit card, or pooled tips) earned in jobs listed by the Treasury as “traditionally tipped occupations.” Mandatory service charges or auto-gratuities do not count as qualified tips.
How do I know how much of my tips or overtime are “qualified” and deductible?
Employers are required to track and report qualified tips and overtime separately for tax reporting. For 2025 and beyond, your Form W-2 will show your total qualified tips (Box 12, Code “TT”) and qualified overtime pay (Box 12, Code “OT”). While it’s not federally required to show this on your paystub, many payroll systems will add these fields for clarity.
Employers are required to track and report qualified tips and overtime separately for tax reporting. For 2025 and beyond, your Form W-2 will show your total qualified tips (Box 12, Code “TT”) and qualified overtime pay (Box 12, Code “OT”). While it’s not federally required to show this on your paystub, many payroll systems will add these fields for clarity.
Does this deduction affect Social Security or Medicare taxes?
No. The deduction only reduces federal taxable income when you file your tax return; it does not lower Social Security or Medicare taxes, which are still calculated on your full wages, including all tips and overtime.
No. The deduction only reduces federal taxable income when you file your tax return; it does not lower Social Security or Medicare taxes, which are still calculated on your full wages, including all tips and overtime.
Are there income limits for claiming these deductions?
Yes. The deductions begin to phase out once your adjusted gross income exceeds $150,000 (or $300,000 for married couples filing jointly). For every $1,000 over the limit, the deduction is reduced by $100 until it is fully phased out.
Yes. The deductions begin to phase out once your adjusted gross income exceeds $150,000 (or $300,000 for married couples filing jointly). For every $1,000 over the limit, the deduction is reduced by $100 until it is fully phased out.
Will this deduction apply to my state income taxes?
No. These new deductions only apply to federal income tax. State income taxes are not affected unless your state specifically adopts similar rules.
No. These new deductions only apply to federal income tax. State income taxes are not affected unless your state specifically adopts similar rules.
How long will these deductions be available?
The deductions are available for tax years 2025 through 2028. Unless Congress extends the law, the provisions will expire after the 2028 tax year.
The deductions are available for tax years 2025 through 2028. Unless Congress extends the law, the provisions will expire after the 2028 tax year.
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