No Tax on Overtime & No Tax on Tips

“No Tax on Overtime”: What Changed, Who Benefits, and How to Capture It

Starting with tax year 2025 (returns filed in 2026), federal law created a temporary income-tax deduction for qualified overtime compensation through 2028. In plain terms: the overtime premium—the “and-a-half” portion required under the Fair Labor Standards Act (FLSA)—may be deducted against federal income tax, up to $12,500 per year ($25,000 for married filing jointly). Married couples must file a joint return to claim this deduction. The deduction phases out at higher incomes (generally above roughly $150,000 for single filers and $300,000 for joint filers).

What counts as “qualified overtime”?

• The premium portion above the regular rate that Federal FLSA requires.
• It must be reported to the IRS (e.g., on a Form W‑2, likely Box 14 or other specified statement).
• Regular wages do not qualify.
• The deduction is available whether you itemize or take the standard deduction.

What doesn’t change?

• Payroll taxes (Social Security and Medicare) still apply to overtime; this is an income‑tax deduction only.
• State and local conformity may vary.

Withholding & Compliance:

• Employees can update 2026 withholding to reflect the new deduction using the current Form W‑4 and its deductions worksheet. Some IRS tools may lag in reflecting brand‑new deductions early in the year.
• Employers and other payors should plan to track and furnish information that shows qualified overtime paid during the year. IRS has announced transition relief for 2025 while forms and systems catch up.
• The IRS also temporarily changed who can qualify for the overtime deduction. For 2025, the overtime deduction will be allowed regardless of which law requires the payment of overtime, instead of the more restrictive FLSA requirement.

Planning Example:

A single filer with $8,000 of qualified overtime premium in 2025 (below the cap and phase‑out) deducts the full $8,000. At a 22% marginal rate, that’s roughly $1,760 of federal income‑tax savings. Payroll taxes still apply.

Action Checklist

For Employees:

• Track the overtime premium separately from straight‑time; keep pay stubs and year‑end statements.
• If you expect to use the deduction, consider updating your Form W‑4 so withholding more closely matches your expected tax.

For Employers:

• Configure payroll to break out and report the overtime premium.
• Monitor upcoming IRS implementation details and use the 2025 transition relief, which states there will not be penalties assessed related to not filing the correct information returns for this item.

Bottom Line: This overtime deduction is meaningful for many non‑exempt workers, but careful documentation—and distinguishing the premium from straight‑time—is essential.

 “No Tax on Tips”: Who Qualifies and How to Document It

A temporary income‑tax deduction is also available for “qualified tips” received in 2025–2028. The annual cap is $25,000 per return, with a phase‑out beginning at $150,000 for single filers and $300,000 for joint filers. Employees and some self‑employed individuals can claim it, subject to important boundaries, and married couples must file a joint return for this deduction to be claimed.

What are “qualified tips”?

• Voluntary customer tips—cash or charged (e.g., credit/debit/e‑payments)—and tips received via permissible tip‑sharing, when properly reported to the employer or to the IRS.
• Mandatory service charges generally do not qualify, such as in the case of a restaurant that imposes an automatic 18% service charge for large parties.
• To claim the deduction, the worker must be in an occupation the IRS identifies as having customarily and regularly received tips on or before December 31, 2024 (final list to be published; proposed lists are available).

Who is not eligible?

• Once the final regulations are issued regarding the determination of whether a trade or business is a specified trade or business for purposes of these rules, self‑employed individuals in a Specified Service Trade or Business (SSTB) are not eligible, and employees of an SSTB also do not qualify. Some examples of SSTB occupations are accountants, attorneys, consultants, and physicians. Until then, the IRS will treat the employee as having received tips in the course of a trade or business that is not a specified trade or business.
• A valid Social Security Number must be included on the return.

Reporting & Payroll:

• Reporting continues: workers must still report tips, and employers still withhold income and payroll taxes on reported tips. The deduction reduces federal income tax only, not FICA/Medicare.
• Employers should expect additional information‑return elements for certain cash/charged tips and the occupation of the tip recipient.

Occupations List:

The Department of the Treasury and IRS have issued proposed guidance and a detailed occupation table that organizes roles across sectors such as food & beverage, entertainment/events, hospitality & guest services, home services, personal services, personal appearance/wellness, recreation/instruction, and transportation/delivery. Expect refinements as comments are processed and the final list is published.

Planning Examples:

• A salon worker who receives and reports $12,000 in qualified tips and meets the occupation and income criteria may deduct the full $12,000.
• A creator receiving voluntary tips through a platform’s tipping feature—if their role falls within the IRS’s final tipped‑occupation list and the tips are reported as required—may also qualify, subject to the same caps, phase‑outs, and occupation limits.

Action Checklist

For Employees/Individuals:

• Report all tips timely; retain point of sale reports, platform payouts, and tip‑share allocations.
• Confirm that your role appears on the IRS and Treasury tipped‑occupations list once finalized; keep a copy with your tax records.

For Self‑Employed Individuals:

• Verify that you are not in an SSTB if you plan to claim the deduction; maintain contemporaneous logs and platform statements.

For Employers:

• Maintain strong tip‑reporting procedures; configure payroll to capture amounts and occupation data.
• Plan for transition relief in 2025 and process updates thereafter. In addition, monitor upcoming IRS implementation details and use the 2025 transition relief, which states there will not be penalties assessed related to not filing the correct information returns for this item.

Bottom Line: The tips deduction can deliver meaningful savings—but only for voluntary, reported tips in covered occupations, and only when documentation and eligibility rules are met.

Frequently Asked Questions

1. How do I know whether my overtime qualifies for the new deduction?

Only the overtime premium—the “and-a-half” portion required by overtime rules—counts toward this deduction. Regular wages do not. Employers must be able to identify this premium separately, and employees should keep pay stubs and year-end statements showing the breakdown. For 2025 only, the IRS is allowing more flexibility around what counts as “required overtime” while systems are updated.

2. Does this mean I won’t pay taxes on overtime or tips anymore?

No. You will still pay payroll taxes (Social Security and Medicare) on both overtime and tips. These deductions only reduce federal income tax, which means potential savings at tax time but not on each paycheck.

3. What tips qualify for the “No Tax on Tips” deduction?

“Qualified tips” include voluntary customer tips—cash, card, or digital—when properly reported. Mandatory service charges (such as automatic gratuities) do not qualify. To claim the deduction, the worker must also be in an occupation the IRS identifies as “customarily and regularly tipped” as of Dec. 31, 2024. A final list will be issued by the IRS.

4. What should employers and workers do now to prepare for 2025?

Employees should track overtime premiums separately, report all tips accurately, and keep documentation. They may also want to adjust their Form W-4 for 2026 to get withholding closer to their expected tax.

Employers should update payroll systems to break out overtime premiums and capture tip/occupation data. The IRS has provided transition relief for 2025, meaning penalties will not apply while systems catch up—but accurate tracking will still be essential.