The One Big Beautiful Bill Act (OBBBA) establishes new individual federal income tax deductions for qualified income from tips and overtime. Although the OBBBA wasn't signed into law until July 4, 2025, these new deductions were effectively made retroactive to January 1, 2025.
The IRS has announced it won't issue revised information reporting forms for tax year 2025. That means workers and their tax advisors will have to determine the amount of eligible tips or overtime pay they received last year. On the bright side, the IRS did issue guidance in November on how to do so. If you're someone who gets tips or works overtime, read on for some helpful background about claiming the new deductions on your 2025 return.
Let's start with tips. For tax years 2025 through 2028, the OBBBA established a new deduction that can potentially offset up to $25,000 of qualified tip income annually. And you don't need to itemize to claim it.
Customers can pay eligible tips in cash, by credit card or through a tip-sharing arrangement. However, the deduction is available only if you receive tips in an occupation that the IRS has designated as customarily receiving such income. In September 2025, the IRS released proposed regulations that list dozens of occupations that qualify for the deduction, grouped into eight categories:
For self-employed individuals, the deduction can't exceed your net income — calculated before the deduction — from the same trade or business in which you earn the tips. If you're married, you must file jointly with your spouse to claim the write-off.
Remember, you must first report your tip income to the IRS on your individual return. Then you can claim the deduction if you qualify. It's important to understand that this tax break isn't an income exclusion. Medicare tax will apply to your tip income, and Social Security tax usually will, too. Also, such income may still be fully taxable for state and local income tax purposes.
The tip deduction that would otherwise be allowed up to the $25,000 limit begins to phase out when your modified adjusted gross income (MAGI) exceeds $150,000, or $300,000 if you're married and file jointly. The deduction phases out in $100 increments for each $1,000 of MAGI, or a portion thereof, exceeding the applicable threshold. In this context, MAGI consists of your regular AGI plus certain tax-free offshore income that you probably don't have.
You must also report tip income to your employer. IRS Publication 531, "Reporting Tip Income," explains how to track and report your tips. But consult your tax advisor for help setting up a tailored, comprehensive employer-reporting approach. Your employer should withhold Social Security and Medicare taxes from the reported amount and include the reported amount on your Form W-2.
Important: If you received tips in 2025 that you didn't report to your employer, or if your W-2 shows allocated tips that exceed what you reported, you must report the additional tip income on your tax return. You'll also need to use Form 4137 to calculate and pay the employee share of Social Security and Medicare taxes. Consult your tax advisor for assistance.
Bear in mind that, for 2025, employers aren't required to report qualified tip income amounts to workers. So, you may have to work with your tax advisor to do so. The IRS guidance includes examples of how to determine the amount of qualified tip income you received last year. Here are some adapted versions:
Server with accurately reported tips. Ann is a restaurant server whose W-2 shows she received $18,000 in tips, from which her employer withheld Social Security tax. The withholding was accurate, and Ann received no additional tips, so she didn't need to complete Form 4137. The $18,000 counts as qualified tip income for purposes of calculating her deduction.
Bartender with additional tips. Bob, a bartender, reported $20,000 in tips to his employer. However, he also received $4,000 in unreported tips. So, he worked with his tax advisor to complete Form 4137, which was filed with his 2025 return. The $24,000 ($20,000 + $4,000) counts as qualified tip income for purposes of calculating Bob's deduction.
Self-employed travel guide with complications. Dex is a self-employed travel guide who operates his business as a sole proprietorship. In 2025, he received $7,000 in tips from customers, paid through a third-party settlement organization (TPSO).
The TPSO sent Dex a Form 1099-K, showing $55,000 of total payments for 2025. His 1099-K doesn't itemize his tips, but Dex kept a log showing the dates, customer names and tip amounts. Because of this thorough documentation, he can count the $7,000 as qualified tip income for purposes of calculating his deduction.
Now let's move on to the new overtime deduction. Before the OBBBA, overtime income was fully taxable for federal income tax purposes. For the 2025 through 2028 tax years, the OBBBA established a new deduction that can offset up to $12,500 of qualified overtime income annually ($25,000 for joint filers). You can claim the deduction whether or not you itemize, but if you're married, you must file a joint return with your spouse to claim the write-off.
All the points we mentioned above about tip income apply to overtime income. You're required to report it and can claim the new deduction only if you qualify. The deduction isn't an income exclusion; Social Security tax may apply, and Medicare tax will for sure. Also, overtime income may be fully taxable for state or local tax purposes.
Qualified overtime income is defined as extra compensation paid in compliance with the Fair Labor Standards Act (FLSA). The law generally requires time-and-a-half pay for worktime exceeding 40 hours in a workweek. We'll call extra hourly amounts "overtime premiums."
Qualified overtime income doesn't include overtime premiums paid to FLSA-exempt employees, such as executives. It also excludes overtime premiums not required by the FLSA but mandated by state law or under certain contracts (for example, union-negotiated collective bargaining agreements). In other words, the overtime deduction is unavailable to employees who aren't subject to the FLSA's overtime pay requirements.
For instance, let's say you worked 20 hours of overtime in the most recent pay period. Under the FLSA, you were paid $37.50 per hour for overtime compared to your regular hourly rate of $25. In this scenario, your overtime premium is $12.50 per overtime hour ($37.50 – $25), and your qualified overtime income for the period is $250 (20 × $12.50).
The overtime deduction that would otherwise be allowed up to the $12,500/$25,000 limit begins to phase out when MAGI exceeds $150,000 ($300,000 for joint filers). Like the tip deduction, the overtime deduction phases out in $100 increments for each $1,000 of MAGI, or a portion thereof, exceeding the applicable threshold.
For example, say you're a single filer for 2025 with $20,000 in qualified overtime income from your regular job as a cable technician. But your MAGI is $175,000 thanks to a profitable side gig, which is $25,000 above the applicable threshold ($175,000 – $150,000). Under the phaseout, your overtime deduction can't exceed $10,000 [$12,500 – (25 × $100)].
Or let's say you're a joint filer for 2025 with $30,000 of qualified overtime income from your tech support job. However, your MAGI is $400,000, which is $100,000 above the applicable threshold ($400,000 – $300,000). Under the phaseout, your overtime deduction can't exceed $15,000 [$25,000 – (100 × $100)].
Although your employer must include overtime pay as taxable income on your W-2, it's not required to separately report your qualified overtime income for 2025. However, some employers may voluntarily notify employees of their total amounts of overtime income. If you'd like to pursue the deduction but your employer doesn't provide the necessary information, consider requesting it. Or you can ask your tax advisor for help with the number-crunching.
In the event you don't receive a separate accounting of your 2025 qualified overtime income, you must make a reasonable effort to determine whether you're an FLSA-covered employee. Generally, this simply entails asking the appropriate person in your organization, such as an HR staff member. As mentioned, if you're exempt from the FLSA's requirements, you can't claim the overtime deduction.
The recently issued IRS guidance includes examples for determining the amount of qualified overtime income received in 2025. Here are two adapted versions:
1. Abe's two alternate realities. In a perfect world, Abe receives a statement from his employer showing that he was paid $5,000 in "FLSA overtime premium" during the year. He and his tax advisor can simply apply the $5,000 when calculating his 2025 overtime deduction.
In a less-perfect world, Abe's employer issues a year-end statement showing total overtime pay of $15,000 in 2025, which includes his overtime premium plus his regular hourly wage for overtime hours. In this case, the overtime amount reported to Abe represents all the time-and-a-half pay for his overtime hours. To determine his qualified overtime income, Abe must divide $15,000 by three, yielding $5,000.
2. Bella's generous employer. Bella works for an organization that pays overtime at twice the regular hourly rate, so her overtime premium equals 100% of regular pay. In 2025, Bella's year-end pay stub shows she received $20,000 of overtime pay at the double pay rate. Because half of that amount represents the allowable overtime premium for deduction purposes, Bella's qualified overtime income is $10,000 ($20,000 ÷ 2).
One slight downside to the new tip and overtime deductions is that they're not "above the line," so they won't reduce your AGI. The lower your AGI, the better, because it increases your odds of qualifying for various income-sensitive tax breaks. Nonetheless, the deductions are valuable tax-saving opportunities well worth pursuing under the right circumstances. If you believe you're eligible for either or both, discuss the matter with your tax advisor.
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