Updates to Tax Deductions for Tips & Overtime
Following the signing of the One, Big, Beautiful Bill Act (OBBBA) on July 4th, 2025, the IRS now allows eligible individuals to take a federal income tax deduction for a portion of their qualified tip and overtime earnings.
- This is a tax deduction, not a complete tax elimination. Tips and qualified overtime are still subject to federal payroll taxes as well as Social Security and Medicare taxes and may be subject to state income taxes.
- The deduction is temporary, applying to wages earned from January 1, 2025, through December 31, 2028.
- The federal overtime tax deduction only applies to the premium pay portion of overtime. For example, if an employee’s regular rate is $20/hour and their overtime rate is $30/hour, only the $10 premium qualifies.
- The federal overtime tax deduction is restricted to overtime required by the Fair Labor Standards Act (FLSA), which is for hours worked over 40 in a workweek. Overtime mandated by state or local law, such as Colorado’s rules for daily hours over 12, does not qualify.
These new federal deductions do not apply to state income taxes. Some states may consider mirroring this legislation, but workers should check their states laws to see if any similar proposals are being discussed.
Employers will continue withholding and reporting taxes as usual. Employees will claim a deduction for these wages when they file their taxes.
For the 2025 tax year, employees will claim the deduction when filing their tax return. Beginning in 2026, some workers may see the benefit on their paychecks as withholding is adjusted.
Maximum deduction limits apply to federal income tax only:
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For Tips: Up to $25,000 per taxpayer.
- For self-employed individuals, the deduction cannot exceed the individuals net income from the business where the tips were earned.
- For Overtime: Up to $12,500 for single filers or $25,000 for joint filers.
Yes, these deductions are subject to phase-out for higher earners. The allowable deduction amount will be reduced by $100 for each $1,000 an individual earns above a Modified Adjusted Gross Income (MAGI) of $150,000.
- Qualified tips must be received in an occupation that “customarily and regularly” received tips before December 31, 2024. The IRS will publish a list of these occupations by October 2, 2025.
- Qualified overtime is limited to the premium portion of pay received as required by the Fair Labor Standards Act (FLSA). This does not include premium pay earned for other reasons, such as holiday pay.