No Tax on Tips or Overtime? What the OBBBA Means for Workers and Employers

A federal tax break that puts real money back in workers’ pockets

Picture this: A healthcare technician picks up regular overtime shifts, adding $10,000 to her annual income. A hospitality worker earns $20,000 in reported tips across restaurants and private events. Until now, those workers paid taxes on every dollar. But starting in 2025, the One Big Beautiful Bill Act (OBBBA) changes that.

Under this new federal law, tips and overtime pay are now eligible for separate above-the-line deductions over the next few years. That means qualified workers can subtract those amounts from their income before calculating taxes, reducing their adjusted gross income (AGI) and potentially lowering their overall tax liability.

These are two distinct deductions. Eligible taxpayers may deduct up to $25,000 in reported tips and up to $12,500 in overtime pay ($25,000 for joint filers) each year. Both provisions are subject to clear IRS qualifications, reporting requirements and AGI-based phaseouts.

Here’s how the deductions work, who qualifies and what steps workers and employers can take to plan for the years ahead.

What to know about the no-tax-on-tips deduction

The OBBBA’s new tip deduction is built for wage earners in service-heavy industries — hospitality, beauty, food delivery, transportation and more — in which tipping is common and often essential to compensation. The law allows eligible taxpayers to deduct up to $25,000 of reported tip income per year, starting with the 2025 tax year.

Who qualifies?

To claim the deduction, a taxpayer must meet four key conditions:

1. Earn income from tips during the tax year in question (2025–2028).
2. Report that tip income on either Form W-2, Form 1099, or directly to the IRS using Form 4137.
3. Work in an occupation the IRS recognizes as a “customarily tipped role” (as defined in a list to be published no later than Oct. 2, 2025).
4. Not be engaged in a specified service trade or business (SSTB) as defined in IRC §199A. This includes industries like law, consulting, financial services and others the IRS categorizes as ineligible.

Technical considerations

The tip deduction is above the line, meaning it applies regardless of whether the taxpayer itemizes deductions. This expands access significantly and simplifies planning for most hourly employees and sole proprietors in qualifying fields.

However, income phaseouts do apply. The deduction begins to phase out for taxpayers with modified adjusted gross income (MAGI) above $150,000 for individuals and $300,000 for joint filers. Above these thresholds, the allowable deduction decreases proportionally until fully phased out.

Notably, taxpayers must file jointly if married and include valid SSNs for all listed individuals to claim the deduction, per current IRS guidance on OBBBA tax provisions.

Tip income documentation

The IRS has stated that tip earnings must be verifiable and reported to be deductible. That includes:

• W-2 Box 1 wages and Box 7 for Social Security tips
• Daily tip logs or records supported by employer payroll systems
• Allocated tips as reported by employers on Form 8027
• Direct reports using Form 4137 for cash tips not already included in W-2 totals

Taxpayers who rely on estimates or cash tips that go unreported will not qualify.

How the no-tax-on-overtime deduction works

The OBBBA also introduces a standalone deduction for qualified overtime income. This targets workers who regularly exceed the 40-hour workweek in industries like healthcare, transportation, emergency response, construction and manufacturing.

For tax years 2025 through 2028, eligible taxpayers may deduct up to $12,500 in overtime compensation each year. For married couples filing jointly, the cap doubles to $25,000 per year. As with the tip provision, this is an above-the-line deduction.

To qualify, overtime pay must meet three standards:

1. The compensation must be paid for hours worked in excess of the standard workweek, consistent with the Fair Labor Standards Act (FLSA) definition of overtime.
2. The income must be reported on a Form W-2 or 1099 issued by the employer or payor. Self-computed or undocumented overtime is not eligible.
3. The employer or payor must document the amount paid for overtime separately from regular wages.

This deduction is not available to self-employed individuals calculating “overtime equivalents.” The IRS was clear on this point in Fact Sheet FS-2025-03, specifying that only employer-verified overtime qualifies.

The tip income phaseout thresholds apply here as well ($150,000 for single filers and $300,000 for joint filers). Beyond these MAGI levels, the deduction begins to phase out gradually and is fully eliminated at higher thresholds.

This provision could prove especially impactful in sectors with rising labor demands, like healthcare and logistics. A properly tracked overtime structure, combined with clear communication about the new deduction, could support recruiting and retention without inflating base wage commitments.

For more on employer reporting obligations related to overtime compensation, visit the U.S. Department of Labor’s overtime compliance guidance.

Who benefits from the OBBBA deductions? Real-world scenarios

The potential tax savings from these deductions are significant, especially for hourly workers whose earnings rely heavily on tips or overtime. Here are three example scenarios based on current law and IRS guidance.

Scenario 1: Hospitality worker with substantial tips

A bartender earns $23,000 in reported tips during the 2026 calendar year. She files as a single taxpayer and her MAGI is $82,000. Her employer includes all tips on her W-2, and she maintains a tip log. She qualifies for the full $23,000 deduction, reducing her taxable income and saving an estimated $3,450 in federal taxes based on her effective rate.

Scenario 2: Joint filers with overtime and tips

A married couple files jointly. One spouse works in construction and earns $16,000 in overtime wages reported on a W-2. The other is a salon professional who earns $21,000 in reported tips on a 1099. Their MAGI is $278,000. They meet all IRS criteria, including joint filing and SSNs. They qualify for the full $16,000 overtime deduction and the full $21,000 tip deduction — giving them a combined $37,000 reduction in taxable income.

Scenario 3: High earner near the phaseout limit

An ICU nurse earns $14,500 in overtime in 2027. Her MAGI is $155,000. She still qualifies for a partial deduction, but not the full $12,500. Because the phaseout range begins at $150,000 and ends at $165,000, she would lose $500 of her deduction for every $1,000 of income over the threshold. With a $5,000 overage, her eligible deduction drops by $2,500. She can still claim a $12,000 deduction, which is significant (but not the maximum).

These examples underscore how important proper planning and documentation will be. Unlike tax credits that apply automatically based on return data, these deductions must be claimed, substantiated and calculated with care. They also have real implications for estimated payments, withholding and year-end tax planning, particularly for high earners or those with variable income sources.

If you are an employer managing a large workforce with tipped or overtime-eligible roles, we can also assist in aligning your payroll systems with IRS compliance requirements for 2025 and beyond. Start with a conversation. Contact a James Moore professional to learn more.

New responsibilities for employers and payroll providers

Employers in tipped and overtime-heavy industries will play a central role in enabling their workers to benefit from the OBBBA deductions. That begins with updating reporting systems and educating employees about what qualifies.

The IRS will expect supporting records that clearly delineate eligible income types. For tip income, that includes Form W-2 Box 7, tip allocation reports (e.g., Form 8027), and in some cases, worker-submitted Form 4137 entries. For overtime pay, employers must separate overtime from base pay and report it accordingly in year-end summaries and payroll ledgers.

Beyond standard income reporting, employers will need to comply with a new informational return rule introduced by the IRS. This requires furnishing clear year-end statements to employees, specifying the total qualified tip and/or overtime income paid during the calendar year. These statements will serve as primary documentation for taxpayers claiming either deduction.

Additionally, employers must be aware of the SSTB exclusion in the tip provision. If your business is classified under a specified service trade or business (such as accounting, law or financial services), your employees may be ineligible for the tip deduction under OBBBA rules.

The stakes are high for getting this right. Inaccurate or vague reporting could disqualify an employee’s deduction claim and potentially trigger inquiries into employer payroll compliance. Businesses that underreport tips or lump overtime into base pay may also face scrutiny from the IRS, particularly if workers attempt to deduct income that can’t be validated.

Payroll software vendors are already releasing updates for 2025 to accommodate these new requirements. Businesses that handle payroll in house should consult with a qualified tax advisor or payroll professional to ensure their systems meet IRS standards for data formatting and income type labeling. (For a detailed guide on how to adjust payroll systems and comply with employer obligations under the new rules, refer to the IRS’s Reporting Requirements Summary.)

Planning strategies to maximize tip and overtime deductions through 2028

With four years of eligibility under the OBBBA, planning ahead is key. Workers, employers and payroll teams all have opportunities to capture meaningful tax savings, but only if they prioritize accuracy and compliance. These deductions aren’t automatic; they must be documented and claimed each year based on eligible income earned.

Start with recordkeeping. Workers should save all employer-issued wage statements and maintain personal records of tip logs or shift summaries. While IRS Form 4137 can be used to report untracked tip income, it’s not a substitute for thorough recordkeeping. The burden of proof remains on the taxpayer.

From a payroll standpoint, employers should begin by ensuring overtime is tracked and reported separately from standard wages. This is especially important in construction, transportation, hospitality and healthcare—industries where shift differentials, holiday bonuses or per diem payments are common. None of those count toward the deduction unless they are explicitly tied to qualified overtime or tip income.

If you are an employer considering adjustments to shift schedules or end-of-year payroll timing, think strategically. For example, high earners approaching the $150,000 or $300,000 MAGI thresholds may benefit from deferring or splitting eligible overtime between tax years. Likewise, workers who anticipate phaseout issues could adjust withholding or shift preferences to maximize deductions while still qualifying.

Another key consideration is joint filing. Taxpayers who are married must file jointly and include valid Social Security numbers for both spouses to be eligible for either deduction. This rule is non-negotiable and will be enforced based on IRS return data.

Businesses may also consider including education on these deductions as part of onboarding or year-end communications. Employers who proactively help workers understand and claim these benefits are more likely to retain talent and avoid downstream payroll errors or questions.

Finally, do not assume software will handle the complexity for you. These deductions introduce new variables into year-end wage reporting and tax filing. If you have questions about payroll classification, employer recordkeeping or how to structure year-end documentation, reach out to a qualified tax professional. The IRS is expected to release more detailed enforcement guidance in 2026, which may include new audit triggers around tip and overtime substantiation.

How to prepare now for OBBBA tax deductions and future savings

The One Big Beautiful Bill Act offers an uncommon opportunity for workers and employers to reduce their federal tax burden through 2028. The deductions for qualified tip income and verified overtime compensation can deliver real savings to hourly employees, especially in labor-intensive and service-oriented industries. However, these provisions reinforce the importance of proactive tax planning, precise recordkeeping and intentional filing decisions.

If you’re wondering how these deductions affect your 2025 tax strategy or what you need to implement now to prepare your payroll and reporting infrastructure, James Moore is here to help. Our tax professionals provide strategic guidance tailored to both individuals and employers, including tip-intensive businesses and high-volume overtime operations.

Don’t leave money on the table in 2025. Contact a James Moore professional to discuss your eligibility and planning options now. The tax code is always changing, but with the right planning, you can stay ahead of it.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.