Guidance On No Tax On Overtime & Tips

The One Big Beautiful Bill (OBBB) Act includes several payroll changes impacting employees, independent contractors and employers. Most notably, it includes new federal income tax deductions for qualified overtime and tip pay, commonly referred to as “no tax on overtime” and “no tax on tips.”

So, what does this mean for you? Let’s dive into these tax savings for workers and what it means for employers. While we are still awaiting further guidance and details, here’s what we know so far.

Key Changes

Both deductions are retroactive to January 1, 2025, and will be available for four tax years (2025-2028), unless extended. These deductions will be available to both employees and independent contractors.

The deductions only apply to federal income tax. These wages are still taxable for the Federal Insurance Contributions Act (FICA), including Medicare and Social Security. They will continue to be taxed throughout the year, with above-the-line deductions being claimed on individual income tax returns, (Form 1040).

Both deductions are available to taxpayers who claim the standard deduction or itemize their deductions. Employers will need to keep track of qualified overtime and qualified tips separately for reporting on W-2 and 1099-series forms. Reasonable approximations will be allowed for 2025, but more accurate reporting will be required in subsequent years.

In August, the IRS announced that there will be no changes to Form W-2, existing 1099-series forms, Form 941, other payroll forms and withholding tables for the 2025 tax year. Employers and payroll providers should continue using current procedures for reporting and withholding.

In the coming months, we expect guidance on the following:

• While the IRS’ decision to delay changes to certain forms for tax year 2025 are intended to provide enough time to implement the changes effectively, it generates further questions. We do expect to see changes to Form 1040 and further guidance from the IRS on claiming the deductions for 2025.
• The IRS is developing updated forms and guidance for tax year 2026.
• What is considered a “reasonable method” for reporting qualified overtime and qualified tips in 2025.
• A list of occupations that customarily and regularly received tips on or before December 31, 2024, is due to be released by October 2, 2025.
• Guidance on whether overtime and tips will be deductible under state laws.
  (Whether or not these amounts are subject to state income tax depends entirely on the laws of the state in which you reside. Most states will continue to tax these amounts. However, several states are currently considering legislation to exempt qualified overtime and tips from state income tax. Employers should monitor state legislative developments.)

No Tax On Overtime

Only “Qualified Overtime” is eligible for the tax deduction. The act defines this as overtime paid to an individual, required under Section 7 of the Fair Labor Standards Act of 1938 (FLSA), that is in excess of the regular rate at which the individual is employed. This refers to the premium-only portion of overtime pay. For example, if an employee’s regular pay is $10/hour, their overtime pay, at time and a half, would be $15/hour. Only the $5/hour premium portion is eligible for the tax deduction.

The following types of pay are “Not Qualified Overtime” and are not eligible for the tax deduction.

• Straight time portion of overtime pay
• Overtime and double time required under state law, required by bargaining agreement, or paid voluntarily by an employer
• Qualified tips

The deduction is limited to $12,500 of overtime income ($25,000 if filing jointly) and begins to phase out when modified adjusted gross income (MAGI) exceeds $150,000 ($300,000 if filing jointly).

No Tax On Tips

“Qualified Tips” are also eligible for a tax deduction. The OBBB defines these as voluntary cash tips received by an individual in an occupation that customarily and regularly received tips on or before December 31, 2024.

Here’s a breakdown of the criteria for qualified tips:

• Cash tips: Includes cash, electronic payments and tips from pooling arrangements.
• Voluntary: The tip must be voluntary, with the customer determining the amount and the recipient. It cannot be negotiated or mandated by employer policy.
• Customarily and regularly tipped occupation: The occupation must have historically received tips before December 31, 2024. The Treasury Secretary is set to publish a list of these occupations by October 2, 2025.
• Reported on tax forms: Tips must be reported on Form W-2, 1099 or 4137.

The following types of pay are “Not Qualified Tips” and are not eligible for the tax deduction.

• Mandatory service charges: Automatic gratuities are not considered qualified tips. Thus, an automatic gratuity of 18% added by a restaurant to a check for a large party would not be considered a qualified tip.
• Non-cash tips: Items such as tickets, passes or other items of value given to an employee are still taxable.
• Certain occupations: The deduction does not apply to individuals working in a Specified Service Trade or Business (SSTB), including fields such as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any business where the principal asset is the reputation or skill of one or more of its employees or owners.

The deduction is limited to $25,000 and begins to phase out when modified adjusted gross income (MAGI) exceeds $150,000 ($300,000 if filing jointly).

The OBBB also expanded the industry coverage of the FICA tip credit. The credit allows employers to reduce their taxable business income by the amount of their share of FICA taxes (currently 7.65%) paid on certain employee tips. Previously this credit was largely limited to the food and beverage industry. It now extends to the beauty and personal care industry, including businesses like barbershops, salons, nail care providers, esthetics services and spas.

Form 1099 Reporting Threshold Change

Also note that the Form 1099-NEC & 1099-MISC filing threshold changes starting in 2026. It increases to $2,000 from $600 and will be adjusted annually for inflation beginning in 2027.

Next Steps

While we wait for the IRS and states to issue further guidance, employers should continue to track qualified overtime and tip pay for employees to use in claiming the deductions for tax year 2025.

It may also be helpful for employers and employees to note the difference between payroll taxes and income taxes in these situations. Qualified overtime and tip pay will still be subject to payroll taxes during the year. The “No Tax” deductions come in the form of income tax deductions on the employee’s tax returns. And while employees will not see an immediate reduction in their take-home pay, they can expect larger tax refunds or reduced liabilities when filing.

Need Help?

Please contact us here or call 800.899.4623 if you have questions or need assistance preparing and filing your 2025 W-2 or 1099-series forms.

You can read an overview about the new tax law here.