The new temporary tax treatment of tips and overtime under the One Big Beautiful Bill Act (OBBBA) has potential implications for both employees and employers. The changes were retroactive to January 1, 2025, leaving many employers with questions. The IRS recently offered some answers.

The Basics 

The OBBBA provisions on tips and overtime wages don’t actually eliminate taxes on this income. Instead, for 2025 through 2028, they establish partial above-the-line deductions that are available regardless of whether you itemize. However, they’re subject to income limitations. In addition, qualified tips and overtime remain subject to federal payroll taxes, as well as state payroll and income taxes (where applicable).

For “qualified tips,” workers generally can claim a deduction of up to $25,000 (regardless of whether the taxpayer is a joint filer). The deduction begins to phase out when the taxpayer’s modified adjusted gross income (MAGI) exceeds $150,000 ($300,000 for joint filers).

Overtime pay is subject to the same MAGI limitations but is deductible only up to $12,500 ($25,000 for joint filers). Notably, while overtime is often considered to mean “time-and-a-half,” the deduction is available only for the “half” portion that exceeds the regular pay rate. Moreover, it’s subject to the definition of overtime under the federal Fair Labor Standards Act, which can vary from state law definitions. As a result, some overtime pay under state law may not qualify for the federal deduction.

Overtime Guidance

The IRS didn’t revise Form W-2 for 2025. So the current IRS guidance regarding the overtime deduction is limited to a draft Form W-2 for 2026. The draft includes a code for reporting overtime (TT). That means employers will need to track workers’ overtime that qualifies for the deduction.

Tips Guidance 

In September 2025, the IRS issued proposed regulations that clarify the tips deduction. Check out our blog, New Tip Deduction Under OBBBA: Treasury Publishes Preliminary Occupations List. For example, under the OBBBA, qualified tips generally refer to cash tips received by an individual in an occupation that customarily and regularly received tips on or before December 31, 2024. The tips must be paid voluntarily, without any consequence for nonpayment, in an amount determined by the payor and without negotiation.

The proposed regs provide that “cash tips” include equivalent payment methods, such as:

• Checks,
• Credit, debit or gift cards,
• Tokens readily exchangeable for a fixed amount in cash (for example, casino chips), and
• Other forms of electronic settlement or mobile payment denominated in cash.

The proposed regs also list 68 occupations that are eligible for the tips deductions, grouped within the following categories:

• Beverage and food service,
• Entertainment and events,
• Hospitality and guest services,
• Home services,
• Personal services,
• Personal appearance and wellness,
• Recreation and instruction, and
• Transportation and delivery.

Additionally, under the proposed guidance, automatic service charges imposed without an option for the customer to disregard or modify them don’t qualify for the deduction. To be voluntary, the customer must be expressly allowed to disregard or modify amounts added to a bill. 

To illustrate, suppose a customer is given a handheld point-of-sale device that prompts the customer to tip 15%, 18%, 20%, “other” or “no tip.” In this situation, the amount tipped would qualify for the deduction because the customer could choose to leave no tip. If that option isn’t available, the minimum percentage required would not be a qualified tip, but any excess tipped over the minimum would be. 

Similarly, if a restaurant imposes an automatic charge for large parties and distributes it to staff, the charge isn’t a qualified tip. But, if the bill includes both the automatic charge and a line for an additional tip, any additional tip is qualified.

FAQ

1. When do the new rules take effect? The OBBBA deductions apply retroactively to income earned on or after January 1, 2025, and remain in effect through 2028.
2. Do these deductions apply to state taxes as well? No. The deductions apply to federal income taxes but do not change state payroll or income tax rules, which still apply where relevant.
3. What counts as “qualified” overtime for the deduction? Only the “extra half” portion of overtime pay under the Fair Labor Standards Act qualifies. Some state-law overtime may not meet this definition.
4. Do automatic service charges count as tips? No. To qualify, the payment must be voluntary. Automatic charges (like for large parties) aren’t eligible, though any additional voluntary tip is.
5. Will there be more guidance from the IRS? Yes. Additional guidance is expected, including finalized W-2 instructions and clarifications around definitions and tracking requirements.

Reduce Your Burden

Employers may encounter challenges when complying with the new reporting requirements for tips and overtime wages. The IRS may publish additional guidance on these deductions in the future.