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No Tax on Tips or Overtime: Federal Provisions Guide

Update (12.12.25):

The IRS has now issued Notice 2025-69 to walk taxpayers through the rules for this inaugural year.

The guidance aims to bridge the gap between the law’s new requirements and the reality that wage reporting systems will not fully catch up until 2026. For tax professionals, the notice offers the framework needed to support clients during this transition. For everyday workers who rely on tips and overtime, it explains how to calculate these deductions, even though 2025 Forms W-2, Wage and Tax Statement, and 1099-K, Payment Card and Third Party Network Transactions, will not yet include separate reporting boxes for these amounts.

Original article and provisions:

The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, introduces two significant above‑the‑line deductions for 2025 through 2028: No Tax on Tips and No Tax on Overtime. Intended for tipped workers earning substantial overtime or tips but below income thresholds, these deductions can reduce taxable income significantly.

No Tax on Tips

Qualified Tips

  • Eligible workers may deduct up to $25,000 in qualified tips from taxable income.

  • "Qualified tips" include voluntary cash or credit‑card tips and tip‑sharing arrangements, historically recognized occupations prior to December 31, 2024. Mandatory service charges do not qualify.

  • Deduction phases out at the following Modified Adjusted Gross Income (MAGI) thresholds: over $150,000 ($300,000 joint). MAGI is your Adjusted Gross Income (line 11 on Form 1040) plus certain items like tax‑exempt interest, non‑taxable Social Security benefits, and excluded foreign income.

Self‑Employed Individuals

Reporting & IRS Guidance

  • By October 2, 2025, the IRS must publish a list of qualifying tipped occupations.

  • Employers and payors must provide statements specifying tip income and occupation.

  • Transition relief is expected for 2025 regarding employer reporting compliance.

State-Level Developments

Several states have proposals to exempt tips and/or overtime from state income taxes. These laws would not be superseded by federal law-state tax treatments remain independent. For example, Colorado has already passed legislation decoupling overtime tax treatment from the federal deduction, effective in 2027; that state will continue taxing overtime income notwithstanding the federal change.

States with pending legislation include:

  • Alabama (proposal to renew prior exemption)

  • Illinois (including bills addressing tips and overtime)

  • Massachusetts, Michigan, New Jersey, North Carolina, Ohio, Nebraska, Kentucky, Maryland, New York, Oregon, Pennsylvania

  • Note: Texas does not have a state income tax.

These remain at the proposal stage into 2026; tracking state sessions is key for multi-state businesses.

Why This Matters for Tipped Workers and Employers

  • Potentially large tax savings- average benefits estimated at $1,800 for tips, $1,400–$1,750 for overtime.

  • Helps reduce taxable income without itemizing, using above‑the‑line mechanics.

  • Phase‑outs require careful calculation, particularly for taxpayers or households near the MAGI thresholds (as defined above);

  • Employers must adapt payroll and reporting to ensure workers can claim properly.

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No Tax on Overtime

Qualified Overtime Compensation

  • You may deduct up to $12,500 per individual or $25,000 on a joint return of qualified overtime pay.

  • Only overtime required under the Fair Labor Standards Act (FLSA) (e.g. time‑and‑a‑half), not premiums under state law or collective bargaining agreements, qualifies.

  • The deduction phases out beginning at Modified Adjusted Gross Income (MAGI) over $150,000 ($300,000 joint).

  • Reported wages must appear on W‑2 (employees) or Form 1099 or Form 4137 (non‑employees).

Employer Implications

  • No changes to Social Security or Medicare taxes-withholding must continue as usual.

  • Employers should track overtime separately and prepare for updated W‑2 and 1099 reporting formats.

  • Payroll systems will likely need updates ahead of IRS guidance, expected soon.

Frequently Asked Questions

Is overtime pay now completely tax-free?

No - Social Security, Medicare, and federal income tax withholding still apply. The benefit comes at tax filing as a deduction for up to $12,500 (or $25,000 joint return) of qualified overtime.

Do tips still count for FICA taxes?

Yes - FICA taxes (Social Security and Medicare) still apply to all tip income. The deduction affects only federal income tax liability.

Can self‑employed individuals deduct tips?

Yes - up to net income from the tipped business. Those in SSTBs under IRC 199A are not eligible for the deduction.

If my state doesn’t pass a similar law, will tips and overtime still be taxed at the state level?

Yes -many states will continue to tax tips and overtime income unless new legislation is passed. Federal law does not override state tax codes. States like Colorado are already adhering to their own separate rules axios.comreddit.com.

Related Millan + Co. Services

Payroll advisory services

Tax planning strategies for tipped industries

Tax compliance for employers

External Resources

  • AICPA commentary and advocacy statements showing professional support for implementation