The IRS has issued important guidance to help taxpayers calculate new federal income tax deductions for qualified tips and overtime compensation under the One Big Beautiful Bill Act (OBBBA), which applies to tax years 2025 through 2028.
These provisions allow workers who earn tips or overtime pay to claim partial deductions on their federal tax returns, advises DunlapSLK, a CPA and business advisory firm based in Chalfont. Since the deductions are claimed at tax time, however, and are not exempt from payroll or state income taxes, employers still must withhold those taxes from paychecks as usual.
For qualified tips, eligible individuals may be able to claim up to $25,000 in deductions. To qualify, tips must be voluntarily given by customers and received in an occupation that “customarily and regularly” received tips before the end of 2024. The IRS’s proposed regulations identify 68 eligible occupations across industries like food service, hospitality, entertainment, personal services, transportation, and recreation. However, the deduction begins to phase out for taxpayers with modified adjusted gross income (MAGI) above $150,000 (or $300,000 for joint filers) and phases out completely at higher income levels.
The overtime deduction allows eligible workers to deduct up to $12,500 (or $25,000 for joint filers) of their qualified overtime compensation. This applies only to the pay that exceeds the regular pay rate under the Fair Labor Standards Act — that is, the “half” portion of “time-and-a-half.” This deduction also phases out with higher MAGI.
Because employers aren’t required to separately report qualified tips or overtime on forms W-2 or 1099 for 2025, the IRS advises that taxpayers calculate their deductible amounts using available records such as Social Security tips reported in Box 7 of the W-2, tips reported to employers on Form 4070, pay stubs, or daily tip logs or other documentary evidence. For overtime, employees may self-report but must use “reasonable methods” to determine the qualifying overtime pay and must make a “reasonable effort” to determine whether you’re considered to be an FLSA-eligible employee. The IRS suggest asking your employers or other service recipients about your FLSA status.
If you receive tips or overtime wages, it’s important to understand this guidance so you can accurately calculate and claim your deductions when filing your 2025 returns. Learn more from DunlapSLK.
