Tips and Overtime Deductions: A New Tax Break for Workers
The One Big Beautiful Bill Act, signed into law on July 4, 2025, introduces a pair of new tax deductions aimed at workers who earn tips and overtime pay. While most headlines have focused on business credits and energy reforms, these provisions offer relief for employees in industries like hospitality, healthcare, and manufacturing.
However, understanding how these deductions work is key, especially when it comes to the difference between a deduction and a credit.
Two New Deductions Starting in 2025
Beginning with the 2025 tax year and available through 2028, eligible workers may claim:
- Up to $25,000 in deductions per return for reported qualifying tip income
- Up to $12,500 in deductions per person for qualified overtime compensation
- Married taxpayers must file a joint return to claim either of these deductions
These deductions are subject to income limitations. The full amount is available to:
- Single filers with modified adjusted gross income (MAGI) of $150,000 or less
- Joint filers with MAGI of $300,000 or less
Above these thresholds, the deductions phase out gradually. Proper documentation is also essential. Tip income must be from a qualifying industry and must be reported on W-2s, 1099s, or other IRS-accepted statements. Overtime must meet the federal definition under the Fair Labor Standards Act, and only the premium portion above regular pay qualifies.
Deduction vs. Credit: Why It Matters
A deduction reduces your taxable income, while a credit reduces your tax liability directly. This is a critical distinction.
For example, if you are in the 22 percent federal tax bracket and you deduct $10,000 in qualified income, your actual tax savings would be about $2,200. A credit of $10,000, on the other hand, would reduce your tax bill by the full $10,000.
So, while these new deductions can still lead to significant savings, they do not offer the same dollar-for-dollar benefit as a credit.
Employer Considerations
For employers, the new deductions bring added responsibility. Businesses should:
- Ensure payroll systems are set up to track and report tip and overtime income separately
- Provide employees with accurate and timely wage statements
- Educate teams on what qualifies for the new deductions
While these rules do not change how employers calculate payroll taxes, they do impact how employees report income for federal tax purposes.
These new deductions for tip and overtime income will benefit many wage earners, but they come with conditions. They offer savings for workers in tipped or hourly positions, but only if income is properly reported and are within the IRS’s guidelines.
Contact your ShindelRock team to ensure you, your business, and your employees get the maximum benefit of this new change.