No Tax On Tips And No Tax On Overtime But Employer Reporting Obligations Are Not Free

As part of the One, Big, Beautiful Bill Act, taxpayers are entitled to a tax deduction on "qualified overtime" and "qualified tips" received during tax years 2025 through 2028. The following is a summary of the new rules as well as guidance on the application of transition relief for the 2025 tax year.

Summary of Terms

• Effective Tax Years: The tax relief applies to overtime and tip income earned from January 1, 2025, through December 31, 2028.
• No Tax on Tips: Individuals in industries where tips are "customarily and regularly" received can deduct up to $25,000 in qualified tips. This applies to any reported cash or charged tips. Qualified industries include hospitality, food service, gambling, grooming, and others listed by the IRS. Mandatory service charges that are tacked onto a bill do not count as qualified tip income.
• No Tax on Overtime: There is a deduction of up to $12,500 for individual filers ($25,000 filing jointly) for qualified overtime paid during a year. Only the portion of overtime required to be paid under the Fair Labor Standards Act (FLSA) is considered to be "qualified overtime." This means that overtime required to be paid pursuant to a collective bargaining agreement or pursuant to state law is not deductible. Further, only the premium portion of overtime is deductible (e.g., the .5 per overtime hour, not the full 1.5 time per hour).
• Eligibility and Limits: The deduction applies to individual federal income tax. There is no corresponding deduction for employers. The deduction phases out for taxpayers with high modified adjusted gross income (over $150,000 single or $300,000 married).
• Required Reporting: Beginning in 2026, employers will have to report the amount of deductible tips and overtime on an employee's Form W-2, in newly designed boxes. The amounts reflected in these boxes should only include the amount that is actually deductible. Therefore, employers should ensure that their payroll systems are set up accordingly. This means that payroll systems that aggregate FLSA-required overtime and non-FLSA overtime need to segregate out the amount of overtime that is actually deductible. The same tracking rule will apply for tip overtime — employers must ensure that the amount that is reported on Form W-2 only includes truly "voluntary" tips and not mandatory service charges or other ancillary charges.
• 2025 Grace Period: IRS Form W-2s for 2025 do not contain the additional reporting boxes for qualified overtime and tips. Therefore, the IRS released guidance that excused employers from mandatory reporting for the 2025 tax year. The IRS encouraged employers to voluntarily report such amounts in Box 14 of W-2 or alternatively furnish a supplemental wage or payroll statement showing the portion of overtime and tips that is deductible. The problem with this approach is that employer payroll systems were not set up during the entirety of 2025 to only track deductible amounts. Some employers are attempting to approximate the amount of deductible overtime and furnish a statement accordingly, while others are telling employees to rely on their payroll stubs or tax advisors.

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