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No Tax on Some Tips and Overtime Adds Burden for Employers

  • Writer: Paul F. Keneally
    Paul F. Keneally
  • Aug 4
  • 3 min read
Employer with calculator and forms

On July 4, 2025, President Trump signed H.R. 1, the “One Big Beautiful Bill Act” (OBBBA) into law. Among other provisions, the OBBBA provides federal income tax deductions for a portion of eligible worker’s tips and overtime earnings. The new law applies to taxable years beginning after December 31, 2024, and is retroactive to January 1, 2025. Both deductions are temporary and are set to expire after the 2028 tax year. It is important to note that these are not tax eliminations and that employers are still required to withhold federal income tax, Social Security and Medicare taxes (FICA), as well as any state and/or local taxes from tips and overtime wages.


No Tax on Some Tips:

The OBBBA creates a separate deduction for tipped workers, allowing them to deduct up to $25,000 in qualified tips from their income subject to federal income tax. This amount is reduced by $100 for each $1,000 by which the tipped worker’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return). The OBBBA caps the deduction at $12,500 (or $25,000, in the case of a joint return) for all employees.


To be considered a qualified tip, the tip amount must be paid voluntarily, is not subject to negotiation and is determined by the payor, not the business or the employee. The deduction is allowed for employees receiving a W-2, independent contractors receiving a 1099-K or 1099-NEC, and taxpayers reporting tips on Form 4137, and is limited for tips earned in occupations that “customarily and regularly” received tips before 2025.


The new law also extends employer eligibility for the FICA tip credit, a benefit previously applicable only to food or beverage service employees, to include tips earned by employees providing beauty services such as hair care, nail care, and spa treatments.


No Tax on Some Overtime:

The new law creates a tax deduction from gross income for qualified overtime compensation. For covered, nonexempt employees, the Fair Labor Standards Act (FLSA) mandates overtime pay at a rate of not less than one and one-half times an employee's regular rate of pay after 40 hours of work in a workweek. The new deduction applies only to the premium compensation paid in excess of an employee’s regular rate of pay. For example, if an employee’s regular rate of pay is $15 per hour, the employee’s overtime rate is $22.50 per hour. Only the $7.50 overtime premium for that hour may be deducted.


Workers can deduct $12,500 ($25,000 in the case of a joint return) in overtime pay from their income subject to federal income tax. For higher earners, the allowable deduction is reduced by $100 for each $1,000 by which the employee’s gross income exceeds $150,000 (or $300,000, in the case of a joint return).


Considerations for Employers:

While these provisions are likely to be popular with many employees, especially hospitality and service industry workers and employees who routinely work significant amounts of overtime, they bring some challenges for employers. Here are a few considerations:

  • Because employers are now required to separately track and report overtime wages and qualified tips on tax forms, they may need to update payroll and reporting systems to comply as employee eligibility for new deductions will rely on accurate employer reporting.

  • Employers should be aware of what are and are not considered qualified tips so they can report properly. Service charges, like 18% gratuities automatically placed on large parties at restaurants, are not tips. Tips received under tip-sharing arrangements count as qualified tips.

  • The deductions offer new opportunities to restructure compensation policies and re-classify positions. For example, some exempt employees who work over 40 hours a week may ask to be reclassified as non-exempt because more of their earnings would be deductible. Employers should consult with their attorney before making changes to their pay practices to ensure compliance with applicable law and to avoid legal problems.


To date, the IRS has not yet issued formal guidance on how these provisions will be applied. We will continue to monitor and provide guidance on how the OBBBA will impact employers. If you have any questions about these provisions or any Labor or Employment law issues, please contact our Labor & Employment team:

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