Key takeaways:
- Deductions for qualified tips and overtime pay are effective beginning in the tax year 2025 and may be taken whether or not the taxpayer itemizes deductions.
- Both deductions are each subject to a maximum of $25,000 annually and begin to phase out at specific income levels for single and join tax filers.
- Taxpayers who work in fields that are considered to be a specified service trade or business (SSTB) are not eligible for the qualified tips deduction.
- Qualified overtime compensation includes only pay in excess of the regular rate, which would be the ½ times pay rate premium when a nonexempt employee earns time and ½.
02/25/2026 — In July 2025, Congress passed H.R.1—referred to by many as the "One Big Beautiful Bill", which enacted some major changes for federal income and estate taxes. Among other provisions, H.R.1. created two new federal income-tax deductions for qualified tips and overtime compensation.
Deductions for qualified tips and overtime pay are effective beginning in the tax year 2025. These deductions are above-the-line and may be taken whether or not the taxpayer itemizes deductions. They also will expire at the end of 2028, unless future legislation extends this deadline.
As a financial professional, you may get questions from clients on how these new deductions work. Understanding the rules for these deductions, which are outlined in this article, can help you offer guidance to clients to help them maximize the benefits of these tax changes
What are the deduction limits for tips and overtime?
Both the qualified tip and qualified overtime deductions are subject to limits and phaseouts. The maximum deduction for each type of compensation is $25,000 annually. The deductions begin to phase out when a single taxpayer’s Modified Adjusted Gross Income reaches $150,000 or a joint filer’s Modified Adjusted income reaches $300,000.
What are qualified tips?
Qualified tips are gratuities voluntarily paid in cash or cash equivalents to certain workers who are employed in an occupation that usually and customarily receives tips. For clarification, the IRS released a preliminary list of 68 occupations who may receive qualified tips.
People who work in fields that are considered to be a specified service trade or business (SSTB) are not eligible for the qualified tips deduction. The Internal Revenue Code defines SSTB, which generally includes professional fields such as finance, health, law, accounting, and performing arts, among others.
The IRS has issued transitional relief providing that tip deductions will not be disallowed solely because the employer is an SSTB until after final regulations are issued.
Tips must be voluntary. Tips must be paid in cash or cash equivalents and amounts must be determined by the customer and not negotiated. The worker must receive tips directly from the customer or through a tip sharing method, and they may not deduct mandatory service charges.
If an individual earns tips in a trade or business as a non-employee, tips may only be deducted only to the extent the trade or business earns income.
Only tips attributable to legal activities are qualified. Married filers must file jointly to deduct qualified tips, and all filers must include their Social Security Number with their tax return.
Estimating a client’s qualified tips deduction
Let’s say you have husband and wife clients who both received $15,000 in qualified tips in 2025 (a combined total of $30,000.) They also file a joint return, have a MAGI of $340,500 and satisfy all the tip deduction requirements for the 2025 tax year.
Because their total qualified tips is greater than the $25,000 maximum, your clients are only able to deduct the lower amount. Plus, their deduction is reduced further because their joint MAGI is over the $300,000 limit. To estimate the additional reduction, divide the amount over the MAGI ($40,500) by $1,000, then round down to the nearest whole number. Multiply that amount (40) by $100 to determine the additional reduction ($4,000).
So, your clients total qualified tip deduction for 2025 is $21,000, after reducing the maximum $25,000 deduction by $4,000.
How should qualified tips received in 2025 be reported?
2025 tax forms have not been modified to reflect the qualified tips deduction. The IRS has issued a notice allowing taxpayers to rely on reasonable methods to determine their qualified tip income. For 2025, penalties are waived on employers for inaccurate information returns or payee statements.
Tips paid to employees in 2025 may be reported in the following ways:
If an individual is self-employed, they may use tip logs, bank deposits and Form 1099-K breakdowns to substantiate tips.
Beginning in 2026, employers must separately report qualified tip income and the employee’s occupation on Form W-2, box 14 (or new box) or Form 1099.
What is qualified overtime compensation?
H.R.1. created a new deduction for certain overtime compensation. Qualified overtime compensation includes only the premium paid in excess of the regular rate, under the Fair Labor Standards Act (FLSA). Generally, this would be the ½ times pay rate premium when a nonexempt employee earns time and ½.
Exempt employees are not eligible. Contracted or extra premiums outside of the amount mandated by the FLSA are not eligible. Married filers must file jointly to deduct qualified overtime, and all filers must include their Social Security Number with their tax return.
What if someone receives paid time off in lieu of overtime pay? Certain government or health care workers may receive time off in lieu of paid overtime compensation. Only the paid time off premium (within FLSA limits) is qualified overtime. For example, an employee who earns 1.5 paid days off for each day of overtime worked would have qualified overtime compensation of the extra ½ day.
How is qualified overtime calculated and reported?
Similar to tips, the IRS allows taxpayers to use reasonable methods to calculate overtime premiums in the absence of separate reporting. Employers may voluntarily include overtime in Box 14 on the W-2 (for other compensation) or separate statements.
Additionally, a collective bargaining agreement, state law or some other arrangement might require overtime compensation at an amount above time-and-a-half. In these cases, compensation exceeding the FLSA-required overtime premium is not deductible.
For example, let’s say a client’s regular rate of pay is $40 per hour, but she receives twice that amount ($80 per hour) for any overtime worked. If your clients works extra hours, she can only deduct $20 of the $80 she receives for those hours ($40 x 0.5 = $20). The additional $20-per-hour of overtime pay isn’t deductible.
Beginning in 2026, employers must separately report qualified overtime compensation on Form W-2, box 14 (or new box) or Form 1099.
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