The Internal Revenue Service and U.S. Department of the Treasury have released new guidance on how tips and overtime are taxed — potentially offering significant savings for millions of workers
Under the recently enacted One, Big, Beautiful Bill Act (OBBBA), individuals who receive “qualified tips” or “qualified overtime compensation” during tax years 2025–2028 may claim federal income-tax deductions that could reduce their taxable income.
Here’s a rundown of what workers should know heading into the 2025-2026 tax season.
What’s New
- Tips deduction — Workers who earn tips may deduct up to $25,000 of qualified tips per year. However, benefit limits begin to phase out for individuals with modified adjusted gross incomes greater than $150,000 annually or $300,000 for joint filers.
- Overtime deduction — Employees who receive overtime pay under the Fair Labor Standards Act may deduct the portion of overtime pay that exceeds their regular rate. For individuals, this deduction can be up to $12,500 per year (or $25,000 for joint filers), subject to the same income-phase-out thresholds.
These deductions apply regardless if workers itemize deductions — meaning even those taking the standard deduction may benefit.
Because the new law was signed into effect in 2025 and tax-reporting systems haven’t caught up yet, workers can’t rely on tax forms alone to claim these new deductions.
Instead, workers who want to claim deductions will need to rely on their own records, such as pay stubs, tip logs, 1099-K or 1099-NEC statements from gig apps, or detailed accounting of hours and extra pay.
The IRS also granted a one-year “transition” period for 2025 so employers and workers will not be penalized if they fail to separately report tips or overtime on pay statements — even though OBBBA ultimately requires that level of reporting.
In short, 2025 is a “transition year,” and the responsibility for documenting qualified tips and overtime falls largely on workers themselves.
What workers should do to prepare
Workers who rely on tips, overtime or gig income should start gathering documentation now.
That includes:
- Pay stubs that document overtime hours or bonuses
- Tip logs with dates, amounts and method of payment
- Earnings statements from third-party platforms if applicable
- Any employer-provided documentation of overtime pay
If you expect to receive tips or overtime in 2025, this new deduction could reduce your federal tax burden significantly.
