Tipped workers and those who earn overtime income got a significant tax break this year. The One Big Beautiful Bill Act now allows a federal tax deduction of up to $25,000 on qualified tips and overtime, a benefit that could dramatically reduce tax bills for people in jobs where they regularly receive tips or for workers who qualify for overtime pay.
This means qualified workers can declare a tax deduction on qualified tips and overtime received in 2025. Under Section 70201 of the OBBBA, the tax deduction will apply from 2025 through 2028.
It’s important to clarify that “tips and OT [overtime] are not ‘tax-free,’ but a federal deduction that has rules,” said Kyle Mostransky, founder and CEO of financial services firm Mostransky and Associates.
“As with many new tax laws, the details matter, and taxpayers will need to understand how this fits into their broader income picture,” added Eric Bronnenkant, CPA and head of tax at Edelman Financial Engines.
Understanding the rules may require some taxpayers to seek the help of tax professionals, but we’ll sort it all out to give filers a clear starting point and framework.
How the tips tax deduction works
Under the new law, single filers and those filing as head of household can deduct up to $25,000 ($50,000 for married couples, filing jointly) for qualified tips. This deduction is an above-the-line deduction and is available whether or not the taxpayer itemizes or takes the standard deduction.
To claim the deduction, you must show tips on a W-2 form from your employer, a 1099-K, or on IRS Form 4070, which is the IRS-approved daily tip log for cash tips. Workers should use form 4137, Social Security and Medicare Tax on Unreported Tip Income, to record unreported tip income as additional wages, along with their share of Social Security and Medicare, or FICA, tax on those tips.
Accurate reporting will be key to correct tax filing, experts agreed. “Document all that you can,” Mostransky said. “Be diligent.”
The new tax law isn’t really ‘no taxes’
The “no tax on tips” name is misleading, Mostransky pointed out, since Social Security and Medicare taxes are still collected. “About a quarter of those taxes are still there because payroll taxes are a flat cost to a majority of the workers,” he said.
Joel Salas, tax expert at JustAnswer.com, agreed. “The most confusing aspect [is that]… people will treat this as an exemption,” he said, which would be wrong. “The clear guidance is that tips and overtime are still income and you’re allowed to deduct if you meet the rules.”
Salas continued, “The most common error I expect to see is that employees and some payroll providers are going to have the mentality to just zero out the income and then accidentally double-count the benefit or mishandle withholding.”
Instead, employees should report their tips accurately, and their employer should withhold the correct amount. Employees won’t see the benefits until they file their tax returns. The above-the-line deduction can reduce the amount of tax they owe and potentially lead to a tax refund or a better one.
However, if you’d rather keep more money in your pocket throughout the year, rather than receive a larger refund at tax time, Bronnenkant recommended reducing withholding to reflect the deduction, or at least a portion of it. “Workers who rely heavily on tips or overtime should periodically revisit their tax projections and overall tax strategy to lower their taxable income as much as possible,” he said.
The philosophy is that you can save, invest or spend your money better throughout the year than waiting for a windfall in the spring. If you’d prefer a larger refund, leave your withholding as is.
Who qualifies for the tips deduction?
The other confusing aspect of the legislation concerns who can claim the deduction and what types of tips qualify. The US Treasury Department released a 13-page list of occupations that are “customarily and regularly” tipped, including common jobs people might think of, like waitstaff and bartenders, as well as fitness instructors, music teachers and movers.
“The occupation list… creates a real eligibility trap, especially for gig workers,” Salas said. This ties to the status of a gig worker who receives tips, but the platform may categorize the role differently than the IRS does.
How the ‘no tax on tips’ rule affects horizontal tax equity
Critics of the new law also argue that it breaks conventions of horizontal tax equity. “Horizontal tax equity is essentially the same ability to pay a similar tax bill,” Salas explained. “If two people make the same amount of money, the tax system usually tries to tax them fairly equally.”
Under the new rules for tips and overtime, people earning the same amount of money may not pay the same amount of income tax.
Salas provided this example of two workers who each earn $60,000 annually:
- Worker A earns the full $60,000 as a base salary, with no tips or overtime.
- Worker B earns $60,000, composed of $45,000 in base pay and the rest in qualified tips.
Since Worker B can now deduct the qualified portion of their tips, their final taxable income is lower than Worker A’s, leading to a difference in their tax bills. “It starts favoring how you earned the income, not just how much you earned that year,” Mostransky said.
Income phase-outs and other exclusions
To claim the tips deduction, the tipped worker must have a Social Security Number (not an Individual Tax ID Number in lieu of an SSN for tax filing). Married couples filing separately cannot claim the deduction.
For self-employed workers, the $12,500 / $25,000 maximum deduction cannot exceed the individual’s net income in the career or business where the tips were earned.
Beyond that, the deduction phases out for higher-income taxpayers, with the allowable deduction dropping by $100 for every $1,000 over $150,000 ($300,000 for joint filers) in MAGI (modified adjusted gross income).
Income phase-outs: Single filers
| Income | Single Deduction |
|---|---|
| $150,000 | $12,500 |
| $160,000 | $11,500 |
| $170,000 | $10,500 |
| $180,000 | $9,500 |
| $190,000 | $8,500 |
| $200,000 | $7,500 |
| $210,000 | $6,500 |
| $220,000 | $5,500 |
| $230,000 | $4,500 |
| $240,000 | $3,500 |
| $250,000 | $2,500 |
| $260,000 | $1,500 |
| $270,000 | $500 |
| $275,000+ | $0 |
Income phase-outs: Married filers
| Income | Joint Deduction |
|---|---|
| $300,000 | $25,000 |
| $320,000 | $23,000 |
| $340,000 | $21,000 |
| $360,000 | $19,000 |
| $380,000 | $17,000 |
| $400,000 | $15,000 |
| $420,000 | $13,000 |
| $440,000 | $11,000 |
| $460,000 | $9,000 |
| $480,000 | $7,000 |
| $500,000 | $5,000 |
| $520,000 | $3,000 |
| $540,000 | $1,000 |
| $550,000+ | $0 |
Eligible and ineligible payment types for taxes on tips
It’s important to understand what the IRS counts as a “tip.” Generally, cash, credit card and digital payments may all count as tips for qualified workers. Service charges, gift cards or even physical gifts are considered taxable but cannot be deducted.
“Clear separation of tips and service charges is going to be important,” Salas said. “With suggested tip screens, default tip options, and gratuities, a big compliance point is separating voluntary tips from mandatory service charges and automatic gratuities, which the IRS has long treated differently for reporting.”
| Eligible | Ineligible |
|---|---|
| Cash | Gift cards |
| Credit card | Cryptocurrency / NFTs |
| Venmo / PayPal / Zelle / Cash App | Service charges automatically added to a bill |
| Digital wallet payments | Mandatory service charges or automatic additions to bills (e.g., 18% tip added for large groups) are treated as service wages, not tips. |
CNET tested and evaluated the major at-home tax software to find the best for self-employed or gig workers. Usually, you can file for free with simple tax returns, but more complex tax situations — such as the new tax on tips and overtime rules — can trigger an upgrade from the free tier to the paid tier. Going with a paid tier may be best, since they usually include access to professional tax advice. For complicated tax returns, it might be best to consult with a professional tax preparer.
Understanding the overtime pay deduction
For workers who receive time-and-a-half overtime pay, the new overtime pay deduction may help reduce their tax liability. But it’s important to realize that “qualified overtime compensation” only refers to the “half” portion of “time-and-a-half” pay. In other words, if a worker earns $30 an hour and then $45 an hour in overtime, they can deduct $15 for every overtime hour worked.
“While most people think about overtime as pay they receive for working beyond a certain number of hours at a 1.5x rate, the IRS does not see it the same way,” Bronnenkant said.
Overtime pay is still subject to FICA taxes deducted from paychecks.
Example:
| Hourly rate | Overtime pay | Deductible | Nondeductible |
|---|---|---|---|
| $30/hour | $45/hour | $15 | $30 |
As with tips, the maximum annual deduction is $12,500 for single filers and $25,000 for joint filers. The phase-out limits of $150,00 and $300,000 MAGI are the same as for deductible tips.
The deduction applies to workers covered under the Fair Labor Standards Act who receive overtime pay for working more than 40 hours in a seven-day work week.
Preparing for sunsetting in 2028
As workers and employers grow accustomed to the new rule, the law is set to sunset in 2029 unless it’s extended. Salas advised keeping the records you have through the amendment window, in case a look-back on prior tax returns reveals you could have claimed a larger deduction.
“Expect these forms to evolve and change, year-over-year, to make it easier for the IRS to track it,” Salas said.
Finally, he warned tipped and eligible overtime workers not to get too comfortable with the new policy. “If it does expire, you want to be ready to switch smoothly back to the old method. This means not building a lifestyle on this benefit because it may not be a lifetime benefit, it’s just good for four years,” he said.
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