Navigating New Tax Deductions: Your Guide to “No Tax on Tips” and “No Tax on Overtime”

Hello there! We know that keeping up with changes in tax law can feel like navigating a maze, especially when new provisions emerge that directly impact your hard-earned income. It’s perfectly normal to have questions and even feel a little uncertain about what these changes mean for your finances. Here at Shah Tax & Accounting Services, we’re committed to simplifying these complexities for you, ensuring you’re well-informed and confident about your tax planning.

You may have heard about the “One Big Beautiful Bill Act (OBBBA),” signed into law on July 4, 2025, which introduced two significant new federal tax deductions: the “No Tax on Tips” and “No Tax on Overtime” provisions. These are designed to offer tax relief for many working Americans, and we’re here to explain what you need to know, what’s clear, and what we’re still awaiting guidance on.

Understanding the Core Concept: Deductions, Not Full Exemptions

First, and this is crucial, let’s clarify a common misconception: these provisions create federal income tax deductions, not full exemptions from all taxes. Think of it like a specialized coupon at a grocery store. You still put all your items (income) in the cart and go through checkout (filing taxes), but for specific qualifying items (your tips and certain overtime pay), you now have a valuable coupon that significantly reduces that portion of your federal income tax bill.

Here’s what that means for you:

• Federal Income Tax Only: The deduction only reduces the amount of your income subject to federal income tax.
• FICA Taxes Still Apply: Your tips and qualified overtime are still subject to Social Security and Medicare taxes (FICA taxes). The deduction does not affect these payroll taxes.
• State and Local Taxes Unchanged: This federal law does not change state or local tax obligations on tips or overtime; these will depend on the laws of your specific state or locality.
• An “Above-the-Line” Benefit: This is an “above-the-line” deduction, which is incredibly beneficial because it reduces your Adjusted Gross Income (AGI). This means it’s available to both itemizing and non-itemizing taxpayers, so you can claim it even if you take the standard deduction.
• Retroactive and Temporary: These deductions are retroactive to January 1, 2025, and are in effect for tax years 2025 through 2028. Unless Congress extends them, they are scheduled to expire for 2029.
• Anticipate Refunds: Federal income tax will likely still be withheld from your paychecks on tips and overtime during the year. However, because of the new deduction, these withheld amounts should be refunded when you file your annual income tax return.

Diving Deeper: “No Tax on Tips” Deduction

If you’re one of the estimated four million individuals who receive tip income, this deduction could significantly impact your take-home pay.

• Maximum Deduction: You can deduct up to $25,000 in “qualified tips” annually.
• Income Phase-Outs: The deduction is reduced for taxpayers with a modified adjusted gross income (MAGI) exceeding $150,000 for single filers or $300,000 for married couples filing jointly. For every $1,000 your MAGI goes over these thresholds, the deduction decreases by $100.
  • Example: Let’s say Sarah is a single filer who earned $30,000 in qualified tips in 2025. Her MAGI is $160,000. While she earned $30,000 in tips, her maximum deduction is $25,000. Since her MAGI exceeds the $150,000 threshold by $10,000 ($160,000 – $150,000), her deduction will be reduced by $1,000 ($10,000 / $1,000 * $100). Therefore, her “No Tax on Tips” deduction for federal income tax purposes would be $24,000 ($25,000 – $1,000).
• “Customary and Regular” Occupations: This deduction applies only to tips received in occupations that customarily and regularly received tips on or before December 31, 2024. This includes roles like waiters or baristas.
  • The Big Uncertainty: The IRS is mandated to publish an official list of these occupations by October 2, 2025. As of early to mid-July 2025, this specific guidance and list were not yet available. This is why staying informed is so important!
  • Excluded Occupations: The deduction explicitly does not apply to tips received for services in “Specified Service Trades or Businesses (SSTBs),” such as health, law, accounting, consulting, or financial services. It also excludes businesses where the principal asset is the reputation or skill of employees or owners.
• What Qualifies as a “Tip”: Qualified tips are amounts voluntarily paid by customers, including cash, check, debit/credit card tips, and tips from sharing arrangements.
• What Does NOT Qualify: Non-cash tips (e.g., tickets, passes, gift baskets) are taxable but do not qualify for this deduction. Also, service charges (mandatory gratuities, like an 18% gratuity for a large party) are not considered tips for this deduction; they are treated as wages.
• Who Benefits Most: While millions may benefit, a study found that households earning $33,000 or less may see little to no benefit as they typically owe little federal income tax. However, about 60% of households reporting tip income could see their tax bills drop by an average of $1,800 a year.

Deep Dive: “No Tax on Overtime” Deduction

If your income often includes overtime, this provision is designed to help you keep more of those hard-earned dollars.

• Maximum Deduction: Individuals can deduct up to $12,500 in “qualified overtime compensation” ($25,000 for joint filers) annually.
• Income Phase-Outs: Similar to tips, this deduction also phases out for taxpayers with MAGI over $150,000 ($300,000 for joint filers). The deduction is reduced by $100 for every $1,000 your MAGI exceeds these thresholds.
  • Example: John and Mary are married and file jointly. In 2025, John earns $15,000 in qualified overtime. Their joint MAGI is $310,000. While John earned $15,000 in qualified overtime, their combined maximum deduction is $25,000. Since their MAGI exceeds the $300,000 threshold by $10,000 ($310,000 – $300,000), their deduction will be reduced by $1,000 ($10,000 / $1,000 * $100). Therefore, their “No Tax on Overtime” deduction for federal income tax purposes would be $14,000 (limited to John’s actual qualified overtime of $15,000, then reduced by $1,000). So, it’s $14,000.
• Specific Definition: The deduction applies only to the “premium portion” of overtime pay (the “half” in “time-and-a-half”) that is required under Section 7 of the Fair Labor Standards Act (FLSA). For example, if your regular rate is $20/hour and you earn $30/hour for overtime, only the $10/hour premium would be considered qualified overtime for the deduction, not the full $30. It does not apply to overtime premiums required only by state laws or collective bargaining agreements.
• Who Benefits Most: This deduction primarily benefits working Americans who regularly work overtime hours. The White House estimates the average overtime worker could see a tax cut of between $1,400 and $1,750 annually. Similar to tips, households earning $33,000 or less may see little to no benefit.

Important Reporting and Filing Considerations

Navigating these new deductions also involves understanding your reporting responsibilities and what to expect from your employer.

• Continue Reporting All Tips: Employees must still report all tips received to their employer (if $20 or more in a month) and report all tips (cash and non-cash) on their annual income tax return. If you received $20 or more in tips in a month and didn’t report them all to your employer, you must report the related Social Security and Medicare taxes on Form 4137 as an additional tax.
• Social Security Number Required: To claim either deduction, taxpayers must include their Social Security Number (SSN) on their tax return, and if married, file jointly with their spouse’s SSN.
• W-2 and 1099 Review – Especially for 2025: For tax year 2025, employers may use “any reasonable method” to estimate qualified overtime and tips on W-2s. This means you should carefully review your W-2 (or 1099 for non-employees) to ensure the correct amounts are reported for tips and qualified overtime. If not, you may need to make amendments once final guidance is released. We recommend tracking your own overtime as a cross-check, as personal records will be crucial for any adjustments. If an employer fails to separately report qualified overtime, you may face challenges claiming the deduction.
• W-2 Changes Are Coming: The IRS is mandated to update tax forms to reflect these deductions. You can expect changes to your W-2, likely including a new dedicated box or code to separately identify qualified tips and overtime compensation, and even your occupation for tips. While the core W-2 form will remain, its internal structure will be modified.

Why Professional Guidance is More Important Than Ever

As you can see, while these new deductions offer fantastic opportunities for tax savings, they come with layers of specific definitions, income phase-out rules, and crucial reporting requirements. The pending IRS guidance, especially the official list of qualifying occupations for tips by October 2, 2025, adds another layer of anticipation.

This is where a trusted tax professional becomes your invaluable partner. At Shah Tax & Accounting Services, we can help you:

• Determine Eligibility: Understand if your specific occupation and income levels qualify for these deductions, especially if you’re near the phase-out thresholds or in an occupation whose status is awaiting IRS clarification.
• Ensure Accurate Reporting: Guide you through what to look for on your W-2 or 1099, and advise on any necessary steps if employer reporting isn’t perfectly aligned with the new rules.
• Maximize Your Savings: Help you apply these deductions correctly to ensure you keep as much of your hard-earned income as possible.
• Stay Ahead of Changes: Keep you informed as new IRS guidance, forms, and procedures are released.

Don’t let the complexities of new tax laws leave you feeling overwhelmed. We’re here to provide the clarity and confidence you need to navigate these changes effectively and ensure you’re taking full advantage of every benefit available to you.

Ready to discuss how these new deductions can benefit your unique financial situation? Contact Shah Tax & Accounting Services today for a personalized consultation. We’re here to help you turn tax uncertainties into opportunities!