You’ll want to sit up and pay attention—new tax laws just kicked in that could affect your take-home pay if you work in a tipped job or pull overtime hours. Starting with the 2025 tax year, the federal government rolled out game-changing deductions under the law (signed July 4, 2025) that effectively create “no tax on tips” and “no tax on overtime” for qualifying U.S. employees.
In this article you’ll learn how the law works, who qualifies, what the limits are, how it affects both you and your employer, and important caveats you must know in this article.
What’s Changed: The Basics
Under the recently passed legislation, eligible workers can deduct certain types of compensation from their gross income, which means those dollars don’t count toward federal income tax. Specifically:
- If you work in an occupation that “customarily and regularly” receives tips, you may deduct up to $25,000 in tip income for tax years 2025-2028.
- If you receive overtime compensation (the “extra” pay required under the Fair Labor Standards Act of 1938 for hours worked over 40 in a week), you may deduct up to $12,500 (single filer) or $25,000 (married filing jointly) of that overtime pay for tax years 2025-2028.
These deductions apply even if you use the standard deduction and do not require itemizing.
Why This Matters
For many service-industry workers, tips form a significant part of income. Prior to this change, tip income was fully subject to federal income tax (in addition to payroll taxes).
The new deduction means you could keep more of your earnings rather than handing a portion over to Uncle Sam. For overtime workers, likewise the half-time premium or equivalent pay you get for extra hours now can be deducted rather than taxed in full.
Who Qualifies for the No-Tax on Tips Provision
To take full advantage you must meet all of these criteria:
- You work in an occupation designated by the Internal Revenue Service (IRS) as one that “customarily and regularly” received tips on or before December 31, 2024.
- Your tips are reported to your employer or to the IRS (on forms W-2, 1099 or 4137, as required).
- Your modified adjusted gross income (MAGI) is below the phase-out thresholds: $150,000 for single filers, $300,000 for married-filing‐jointly. Beyond those levels the deduction phases out.
- The law is in effect for tax years 2025 through 2028; beyond 2028 the deduction expires unless law changes.
If you make above the thresholds, you may still qualify but the benefit will gradually shrink.
How the Deduction Works
Rather than being a credit, the “no tax on tips” benefit is a deduction—it reduces your taxable income. For example, if you earned $10,000 in tipped income and qualify, you deduct that amount (up to the cap) and you pay federal income tax only on your regular wage plus remaining taxable income. The deduction is limited to $25,000 for eligible workers in most cases, per tax year.
Also note: you still owe payroll taxes (Social Security, Medicare) on tip income. The deduction only covers income tax. Employers must still report and withhold properly.
Who Qualifies for the No-Tax on Overtime Provision
For the overtime deduction you must meet these conditions:
- You received “qualified overtime compensation” — i.e., pay you earned because you worked more than 40 hours in a week and received overtime premium pay as required by the FLSA.
- The deduction amount is limited to the excess over your regular rate (for instance, the “half-time” portion of a time-and-a-half rate).
- Your MAGI must be under $150,000 (single) or $300,000 (joint) to receive the full benefit; higher incomes phase it out entirely by certain thresholds.
- The maximum deduction is $12,500 for single filers ($25,000 married filing jointly) each tax year, applicable 2025 through 2028.
This means if you work overtime and earn premium pay you didn’t fully absorb in taxes, this deduction can reduce your taxable income accordingly.
What You Should Do Now
If you are in a tipped occupation or earn meaningful amounts of overtime pay, take these steps:
- Review your W-2 and tip reports to ensure you have properly reported tip income (even cash tips).
- Ask your employer how they will handle the new reporting requirements (they must begin tracking and reporting qualifying tip and overtime compensation data).
- During tax season 2026 (for tax year 2025) prepare to claim the new deduction on your federal tax return. Use IRS guidance and any new forms/releases.
- Adjust withholding if necessary once official IRS and employer guidance for W-4 forms reflect the new deductions for 2026 onward.
- Keep all documentation—tip income records, overtime pay statements, employer reporting—so you are ready if audited.
What the Limits and Fine Print Are
While the policy shift appears generous, there are important caveats and limitations:
- The deduction doesn’t apply to all tipped jobs — only those the Treasury/IRS designate as “customarily and regularly” tipped. If your occupation is not on that list you may not qualify.
- The overtime deduction only covers the premium over regular pay, not the entire overtime earnings.
- Your deduction may phase out at higher incomes — it does not apply fully for high earners.
- It only lasts through tax year 2028, after which it may expire unless further legislation extends it.
- It impacts federal income tax only — state income taxes or local taxes may still apply. Payroll taxes are still owed on tip and overtime income.
- According to some estimates fewer than 9 % of tax filings will actually benefit from the overtime deduction, because the rules are restrictive and apply only to certain incomes and circumstances.
Who Gains Most, Who Gains Least
The greatest benefit falls on mid-income workers in tip-heavy jobs who make less than the phase-out thresholds. For example a waiter or hairstylist earning $60,000 a year with $10,000 in tips stands to gain meaningful tax savings. However, the many workers in tipped jobs who earn below the federal income tax threshold (and already pay little or no federal income tax) may see little or no benefit. Likewise, higher-income earners may see the deduction phase out entirely.
Critics point out that while the deduction sounds dramatic, many low-wage workers still owe payroll tax and may not owe significant income tax anyway, so the real take-home benefit may be modest. Others note it may incentivize more reliance on tipping systems rather than raising base wages.
Impact on Employers
Employers must adapt. They will need to track and report qualifying tip income and overtime premium pay on W-2 or 1099 forms. For 2025 the employer won’t necessarily make the change to withholding mid-year, but in 2026 withholding adjustments may reflect the deduction to avoid large refunds at filing time.
Employers in beauty, hospitality and service industries (including some new categories like massage therapists or cosmetologists) must pay attention. They may also benefit from expanded tax credits for payroll taxes paid on tips in certain service/beauty occupations.
Practical Example
Imagine you’re a bartender earning $50,000 annually plus $15,000 in cash tips. Under prior law you paid federal income tax on that $15,000 of tips plus payroll taxes. Under the new deduction you can deduct that $15,000 (if your MAGI and occupation qualify) from your taxable income, reducing your tax bill by your marginal rate on that amount (say 22% ≈ $3,300 saved).
If you also worked significant overtime and earned a $5,000 overtime premium, you could deduct that too (within the limit). Thus your take-home pay improves meaningfully.
Important Considerations Before Claiming
- Wait until IRS issues the full list of eligible occupations and any final forms (expected October 2025 or later).
- Verify your income falls under phase-out thresholds to maximize benefit. Exceeding thresholds could reduce or eliminate your deduction.
- Keep accurate tip and overtime documentation—monthly tip logs, employer statements, time-card records.
- Consult a tax professional—especially if you are self-employed, earn mixed income, or your job classification is unclear.
- Monitor state tax rules—some states may still tax tips and overtime differently, and state withholding may not adjust automatically.
Conclusion
If you work in a tipped occupation or earn overtime, the new “no tax on tips and overtime” provisions offer a meaningful opportunity to keep more of your money—provided you qualify and your income falls in the eligible range. The deductions reduce your federal income tax liability beginning with the 2025 tax year (filed in 2026).
But don’t assume it’s free-money: payroll taxes still apply, state taxation may vary, and eligibility is limited by occupation, income thresholds and expiry dates. For many service-industry and overtime-earning workers, it’s a chance to lock in tax savings—just be sure to follow the rules, track your income and work with your employer and tax advisor to leverage it properly.