The One Big Beautiful Bill Act (“OBBBA”) was signed into effect by President Trump on July 4, 2025. Included in the OBBBA was the “No Tax on Tips” provision, which grants service-sector workers an above-the-line deduction of up to $25,000 of qualified tip income earned between January 1, 2025, and December 31, 2028. Also included is the “No Tax on Overtime” provision, which, during the 2025-2028 tax years, grants a deduction to employees and independent contractors of up to $12,500 of qualified overtime premium pay each year ($25,000 for joint filers).
No Tax on Tips
The No Tax on Tips deduction is capped at $25,000 per year. This means employees will be able to deduct up to $25,000 per year, and once the deduction exceeds the cap, the amount is reduced by $100 for each $1,000 the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return). The deduction is an above-the-line deduction for “qualified tips”.
An “above-the-line” deduction is subtracted from an employee’s gross income before calculating their adjusted gross income, which has the effect of eliminating from tax the amount deducted. Unlike “standard” deductions, above-the-line deductions are available to all taxpayers, including those who do not itemize their deductions.
A “qualified tip” is a tip that is (i) paid voluntarily without any consequence in the event of nonpayment, (ii) not the subject of negotiation, and (iii) determined by the payor. Thus, for example, a mandatory service charge imposed by the employer for a banquet will not qualify for the deduction, and neither will a required gratuity that a restaurant adds automatically to a bill for large parties. Failing to make this distinction may lead employees to claim deductions to which they are not entitled.
To qualify for the deduction, the tips must be received by an individual engaged in an occupation that customarily and regularly received tips on or before December 31, 2024 – this will be defined by the Treasury Secretary. This limitation appears designed to deter employers outside the hospitality and service industries from recharacterizing a portion of their employees’ existing incomes as “tips” in an attempt to take advantage of the new deduction.
Employers will still be required to include on Form W-2 the total amount of cash tips reported by the employee, as well as the employee’s qualifying occupation. For 2025, the employers are authorized to “approximate” the amount designated as cash tips pursuant to a “reasonable method” to be specified by the Treasury Secretary. Tips will still be subject to federal income tax withholding, and employers will need to monitor their state’s specific laws.
No Tax on Overtime
No Tax on Overtime will be applicable to both employees and independent contractors. Similar to No Tax on Tips, the provision will be effective from January 1, 2025, through December 31, 2028. The exclusion would be taken by the individual as an above-the-line deduction on their federal income tax return. The deduction is capped at $12,500 for single filers and $25,000 for joint filers and phased out by $100 for each $1000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return).
The deduction will be available for “qualified overtime compensation,” which is defined as the premium portion of overtime that is required by § 7 of the Fair Labor Standards Act (“FLSA”) and that is paid in excess of the employee’s regular rate. In practical terms, it is the extra “½ time” earned when a taxpayer is paid “time and a half” for hours worked beyond 40 in a work week. Qualified tips cannot also be claimed as qualified overtime.
Currently, overtime is not separately stated. With the implementation of this deduction, employers and contractors will be responsible for reporting any qualified overtime compensation as a separate line item. The No Tax on Overtime provision does not create an exclusion from income, and overtime should still be reported and withheld on wages.
Employers should carefully consider their payroll policies and practices to ensure they are updated to properly account for any changes these provisions may bring. Additionally, employers who will have employees affected by these provisions should consider providing training or education to comply with the updated requirements.
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Authors H. Wayne Young and Colton T. Meister