This article is authored by OnPay, a top-rated payroll provider for small businesses with more than 30 years of experience in payroll, taxes, and small business compliance.
Starting in 2025, the “One Big Beautiful Bill” (H.R.1) introduced two temporary, but headline-grabbing federal tax deductions: one for tip income and another for overtime pay. These deductions are set to reduce year-end tax liabilities for hourly and service workers, but each comes with important nuances for employers. Those handling their own payroll administration and IRS reporting need to pay close attention.
In this overview, we explain how the new deductions work and how they affect business owners.
The no tax on tips deduction
What changed
Employees in jobs that regularly earn tips can now claim a deduction for federal income tax on tip income (up to $25,000 per year) when they file their taxes for tax years 2025–2028.
Who qualifies for this deduction?
- The deduction applies to workers in occupations that typically receive tips (e.g., restaurant servers, bartenders, nail technicians, etc.).
- The deduction is an “above-the-line” deduction, which means this allowance is available even if you take the standard deduction.
- The deduction is applicable only to tip income reported to the employer and reflected on the employee’s Form W-2 (or the contractor’s Form 1099-NEC or Form 1099-K).
- The deduction begins to phase out at $150,000 of adjusted gross income ($300,000 for joint filers. For every $1,000 of income above the threshold, the deduction is reduced by $100.
To claim the deduction, taxpayers must have a valid Social Security number.
List available
The US Treasury has published an official list of qualifying tip-earning occupations that’s used to determine eligibility for this deduction.
What employers need to know
- The deduction does not have any impact on an employer’s tax liability. Employers will continue to withhold and remit federal taxes on tipped wages.
- The deduction only applies to federal income tax on tip income. Other payroll taxes, such as Social Security and Medicare, are not eligible for the deduction.
- In addition to withholding and remitting federal taxes on tipped wages, employers are responsible for reporting IRS-stipulated payroll information on various forms, including Form W-2 and Form 941. Employers operating large food and beverage establishments must also file Form 8027.
Note that Form W-2 (and applicable 1099s) will include a separate identification of qualified tip income, so employees are able to accurately claim the deduction when filing their individual tax returns.
The no tax on overtime deduction
What changed
Eligible employees can now claim a deduction of up to $12,500 per year for federal income tax on qualified overtime pay when they file their taxes for tax years 2025–2028.
Who qualifies for this deduction?
- Hourly workers eligible for overtime compensation under the Fair Labor Standards Act (FLSA) may claim this deduction when filing their taxes.
- For this deduction, “overtime” refers only to time worked above 40 hours in a workweek, as defined under the Fair Labor Standards Act (FLSA), and does not include overtime as defined under state or local overtime laws, or company overtime policies.
- Overtime required under state or local laws, union agreements, or company policies does not expand eligibility for this federal deduction.
What tax qualifies for the deduction?
- The deduction is limited to federal income tax (FIT); it does not apply to Social Security, Medicare, or state income tax. The deduction is further limited to FIT associated with overtime premium compensation (0.5 x regular rate); it does not apply to regular-rate compensation.
- Similar to the “no tax on tips deduction,” this deduction begins to phase out at $150,000 of adjusted gross income ($300,000 for joint filers).
- For employees to claim the deduction on their tax returns, employers must report eligible overtime premium earnings separately on each employee’s Form W-2.
- This separate reporting allows employees to identify the deductible portion of their overtime pay when filing Form 1040.
What employers need to know
- The deduction does not have any impact on an employer’s tax liability. Payroll taxes (Social Security and Medicare) still apply to all overtime earnings (up to specified levels).
- Employers are still responsible for withholding this tax, with new requirements for reporting payroll information on various forms, including Form W-2 and Form 941.
- Payroll systems may need to be adapted – or adopted – to stay compliant when tracking and reporting qualified overtime earnings for each worker.
- The federal government is expected to issue further guidance to facilitate implementation.
This can feel like a lot to keep track of so we put together the table below to make this easier to see what’s happening.
| Provision |
Maximum deduction per individual |
Applies to |
Income phase out begins at |
Payroll tax still owed by employers |
Years effective |
| No tax on tips deduction* |
$25,000 |
Workers in tip-earning occupations |
$150,000 ($300,000 for joint filers) |
Yes |
2025–2028 |
| No tax on overtime deduction* |
$12,500 ($25,000 if filing jointly) |
Overtime-eligible workers |
$150,000 ($300,000 for joint filers) |
Yes |
2025–2028 |
*Both deductions apply only to federal income tax and do not affect Social Security, Medicare, or other payroll taxes.
What stays the same for employers and employees
Payroll taxes
- Employers must continue to withhold and remit federal income tax on reported tips and qualified overtime pay.
- Neither deduction affects Social Security and Medicare tax liabilities. Employers and employees continue to pay 7.65% each on all tip and overtime earnings (up to specified levels).
- The overtime deduction does not apply to compensation for overtime defined under state laws.
Reporting requirements
- Employers must accurately report all wages, tips, and overtime on employees’ Form W-2s.
- If applicable, employers must also accurately report regular compensation and tip compensation on contractors’ applicable 1099s.
Easy and cost-effective
“OnPay saves me so much time and gives me real peace of mind. I love that it automatically calculates taxes—when I was doing payroll on spreadsheets, I was constantly triple-checking every calculation. Now I enter the hours and it handles the rest. It’s honestly great.”
— Jessica Bortner, Bortner and Sons Construction LLC
Compliance watch and what to expect from the IRS
Federal agencies, including the IRS and Treasury, have issued initial guidance on how tip and overtime income should be reported for tax year 2025. Additional clarifications and form updates may continue to roll out as implementation progresses. Employers should work with payroll providers to update systems and ensure compliance for 2025–2028.
Temporary relief with long-term impact?
The “no tax on tips deduction” and “no tax on overtime deduction” offer immediate financial benefit for many working Americans. However, they introduce a layer of complexity for employers.
Maintaining accurate payroll records and ensuring taxes are withheld and remitted in a diligent manner are essential to ensuring compliance with federal, state, and local government bodies. Leveraging cutting-edge HR and payroll software, such as OnPay, can help you streamline your operations and mitigate risk.
