If you’ve caught the buzz about the One Big Beautiful Bill Act (OBBBA), you may have heard the eye-catching headline: “No taxes on tips and overtime!” It sounds appealing for servers, bartenders, nurses, mechanics, and anyone who hustles for extra pay. If you’re one of them, you might be picturing bigger paychecks with zero IRS strings attached.

But before you start planning a tax-free vacation with those extra dollars, we need to clear up some confusion. The OBBBA doesn’t actually make tips and overtime income “tax-free.” Instead, it creates two brand-new deductions that certain taxpayers can use to offset those earnings.

Let’s walk through what this really means for both workers and employers, and why some paperwork changes are coming your way.

The Reality: Deductions, Not Exclusions

Here’s the key point: tips and overtime are still taxable income. You’ll still see them included in your wages and subject to withholding. The difference under the OBBBA is that you may qualify for a deduction to reduce your taxable income, which lowers the amount you owe.

Think of it like this: instead of keeping the IRS completely out of your tip jar or overtime check, the government is giving you a coupon to reduce the tax bite later.

Tip Income Deduction

The tip deduction is capped at $25,000 per year, and it’s available whether you claim the standard deduction or itemize.

However, it phases out for higher-income taxpayers. Once your modified adjusted gross income (MAGI) exceeds $150,000 ($300,000 for married couples filing jointly), the deduction starts to phase out. Taxpayers with MAGI greater than $400,000 if single or $550,000 if married filing jointly, won’t be able to claim a deduction.

There’s another catch: only workers who earn tips in an occupation that “customarily and regularly received tips” before 2025 can claim the deduction. Fortunately, the Treasury Department’s preliminary list of eligible occupations is pretty extensive. It includes expected occupations like bartenders, baristas, baggage handlers, hotel housekeeping staff, hairstylists, valet parkers, and food servers. But it also includes some not-so-obvious choices like social media influencers, electricians, plumbers, wedding planners, and hot air balloon pilots.

Another thing to reminder is that the tip income has to first be reported (via W-2, 1099, or self employed income) before you can then take the deduction.

The deduction is also temporary, applying only from 2025 through 2028. You’ll still owe federal payroll taxes on tips and may owe state income taxes, depending on your state’s rules.

Overtime Income Deduction

The overtime income deduction is capped at $12,500 for single filers and $25,000 for married people filing jointly. Like the tip income deduction, it’s available whether you claim the standard deduction or itemize.

It also starts to phase out if your MAGI is more than $150,000 ($300,000 for joint filers).

To qualify, you must be a W-2 employee—gig workers and independent contractors aren’t eligible. And your overtime must meet federal labor standards, which require time-and-a-half for hours worked beyond 40 hours per week.

One common point of confusion with this deduction is how it applies to overtime income. Not all overtime income counts. The tax break only applies to the premium portion above your normal hourly rate. For example, say your standard wage is $20 per hour and your overtime rate is $30 per hour. You can only deduct $10 for each hour of overtime you work during the year.

Like tip income, this deduction only applies to 2025 through 2028, and you’ll still owe federal payroll taxes and potentially state income taxes on overtime income.

What This Change Means for Employers

Here’s where things get a little sticky for small business owners. Because the IRS won’t revise Form W-2 for the 2025 tax year, you won’t see new boxes showing “qualifying tips” or “overtime wages.”

Instead, you’ll need to keep detailed payroll records to track tip and overtime amounts separately. Because the law applies retroactively to the beginning of 2025, you may need to reconfigure your payroll systems to properly track these numbers. Employees may ask for statements breaking down their income so they can properly claim the deduction on their tax return.

Expect lots of questions early on as workers try to figure out how much of their income qualifies.

Yes, this adds another layer of complexity to tax season. But here’s the silver lining: these deductions are an opportunity for workers to keep more of what they earn. And for employers, helping your team understand the rules is a great way to build trust and loyalty.

Ready for Clarity?

The One Big Beautiful Bill Act didn’t wave a magic wand to make tip and overtime income disappear from the IRS’s radar. Instead, it gave workers two targeted deductions to help soften the blow. This means workers can either adjust their withholding or get a break when they file, and employers need to be ready to track, document, and explain tip and overtime income for the team, even if it’s not on the W-2.

Remember, you don’t have to figure it out alone. At NewWay Accounting, we help small business owners and individuals cut through the noise, understand the real impact of tax law changes, and keep more of what they earn.

Contact NewWay Accounting to get ahead of these changes and make sure you’re ready when tax time comes around.