If you work for tips or regularly clock overtime hours, there’s a new federal tax break that could put real money back in your pocket. As part of the One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, Congress created two new deductions — commonly called “no tax on tips” and “no tax on overtime” — that apply to tax years 2025 through 2028.
These aren’t tax credits, and they’re not a change to how your paycheck is withheld. They’re new deductions you claim when you file, and understanding exactly how they work will help you avoid leaving money on the table (or overestimating your refund).
What Is “No Tax on Tips” and “No Tax on Overtime”
Both provisions work as an above-the-line deduction — meaning you can claim them whether you take the standard deduction or itemize. They reduce your taxable income, not your tax bill directly, and they only apply to federal income tax (not Social Security or Medicare payroll taxes, which are still withheld as usual).
They’re temporary: both deductions are currently scheduled to apply only to tax years 2025 through 2028, so this isn’t a permanent change to the tax code (at least not yet).
Who Qualifies for the Tips Deduction
The tips deduction applies to workers in occupations that customarily and regularly receive tips — think wait staff, bartenders, salon and spa workers, personal trainers, rideshare and delivery drivers, and similar service roles. A few key rules:
- Tips must be voluntary (not mandatory service charges) and properly reported as income
- The deduction is capped at $25,000 per year
- It phases out for higher earners: above $150,000 in Modified Adjusted Gross Income (MAGI) for single filers, or $300,000 for joint filers
If you’re a gig worker or self-employed and receive tips (say, through a delivery app), the same general framework applies, but how the income is reported matters — keep good records either way. Self-employed tips count only up to the net profit of the business that earned them, and tips earned in a “specified service trade or business” aren’t eligible. Until final rules arrive, though, the IRS is treating anyone in a listed tipped occupation as not being in one.
Two details catch people off guard. The $25,000 limit applies per return, so a married couple who both earn tips share one $25,000 limit rather than getting $50,000. And an automatic gratuity doesn’t count. In the IRS’s own example, a restaurant adds an 18% charge to every party of six or more; even though the server receives that money, it isn’t a qualified tip because the customer didn’t choose it. A tip the customer picks on a card reader, including “no tip” as an option, does count.
Example: A Server’s Tips Deduction
Say you’re a single server and your W-2 shows $18,000 in box 7 (tips reported to your employer), with a MAGI around $48,000. Your deduction is the full $18,000, because you’re under both the $25,000 limit and the $150,000 income line. If your top bracket is 12%, that’s roughly $2,160 less income tax. You still owe Social Security and Medicare tax on those tips.
Now change the picture: same $18,000 in tips, but your MAGI is $160,000 as a single filer. You’re $10,000 over the line, and the deduction drops by $100 for every $1,000 over it, so $1,000 comes off and you can deduct $17,000.
Who Qualifies for the Overtime Deduction
The overtime deduction is narrower than many people assume. It doesn’t apply to your entire overtime paycheck — it applies specifically to the extra “half” portion of time-and-a-half pay required under the Fair Labor Standards Act (FLSA). In other words, it’s the premium above your regular hourly rate, not the whole overtime wage.
Key details for the overtime deduction:
- Must be reported on your W-2, 1099, or another qualifying statement from your employer or payer
- Deduction cap: $12,500 for single filers, $25,000 for joint filers
- Same MAGI phase-out thresholds as the tips deduction
- Married filers must file a joint return to claim this deduction — filing separately disqualifies you
How to Figure the Overtime Premium
Most pay stubs show overtime pay as one lump sum, not split into “regular” and “premium” parts. The IRS lets you back into the number. Think of time-and-a-half as three half-rate units per hour: two make up your regular rate and one is the extra half. Only that extra unit qualifies. So if your statement shows the total paid for overtime hours, divide it by three.
For example, say you earn $20 an hour and worked 100 overtime hours at $30. You were paid $3,000 for those hours, and $3,000 divided by 3 is $1,000. That $1,000 is your qualified overtime. If your employer pays double time instead, only the time-and-a-half portion counts. On $20,000 of double-time overtime pay, the IRS example puts the qualifying amount at $5,000, not the full $10,000 premium.
Not everyone with overtime pay qualifies. You must be covered by the Fair Labor Standards Act and not exempt from it. If your state or union contract gives you overtime but you’re not FLSA-eligible, that pay doesn’t count. Extra pay for holidays and weekends doesn’t count either unless you also worked more than 40 hours that week.
Tips vs. Overtime at a Glance
| No tax on tips | No tax on overtime | |
|---|---|---|
| Maximum deduction | $25,000 per return | $12,500 single, $25,000 joint |
| Phase-out starts at MAGI | $150,000 single, $300,000 joint | $150,000 single, $300,000 joint |
| Phase-out rate | $100 per $1,000 over the line | $100 per $1,000 over the line |
| What counts | Voluntary cash and card tips in an IRS-listed tipped occupation | Only the “half” premium in time-and-a-half required by the FLSA |
| Married filing separately | Not allowed | Not allowed |
| Valid Social Security number | Required | Required |
How to Claim These Deductions
The IRS created a new form, Schedule 1-A, for the deductions the OBBBA introduced: tips, overtime, car loan interest, and the $6,000 senior deduction. Tips are Part II and overtime is Part III, and the total flows to your Form 1040. You can claim them whether you take the standard deduction or itemize.
Which step applies to you depends on where you are in the filing calendar:
- You haven’t filed your 2025 return yet. The extension deadline is October 15, 2026, so include Schedule 1-A with your return.
- You already filed your 2025 return without these deductions. File Form 1040-X and attach Schedule 1-A. The deductions go on line 4b of the 1040-X, and a refund claim generally has to be filed within three years of when you filed the original return. The IRS says to allow 8 to 12 weeks, and sometimes up to 16.
- You’re planning your 2026 return. Starting with 2026, employers and payers must separately report qualified overtime, and the W-2 and 1099 forms are being updated to show cash tips separately. Check those boxes before you rely on your own estimate.
- Your 2025 W-2 doesn’t break anything out. That was normal for 2025. For tips, the IRS lets you use the amount in W-2 box 7 or the tips you reported to your employer on Form 4070. For overtime, use any separate statement your employer gives you, or the divide-by-three method above. Keep whatever you used.
Double-check that the figures on your W-2 or 1099 match your own records before filing. Mismatches can slow down processing or trigger a follow-up notice.
How This Affects Insurance and Benefits Planning
Because these are deductions that reduce your taxable income, they can also lower your MAGI — which matters for other income-tested programs. If you or a family member gets health coverage through the ACA Marketplace, a lower MAGI could mean a larger premium tax credit. It can also affect retirement account contribution limits and eligibility for other income-tested benefits, so it’s worth factoring into your overall tax and benefits planning, not just your refund estimate.
FAQ
Does this apply to self-employed or gig workers?
Tips: yes, if they’re qualified tips in a listed occupation and you have net profit to deduct them against. Overtime: generally no, because the deduction requires you to be an FLSA-eligible employee. Self-employed taxpayers should confirm their situation with a tax professional, since reporting mechanics differ from traditional W-2 employment.
What if my employer doesn’t report tips or overtime separately?
Talk to your employer or payroll department as soon as possible. Without separate reporting of qualifying tips or the overtime premium, it may be difficult to substantiate your deduction if the IRS asks for documentation.
Related: $10,000: The New Car Loan Tax Deduction Most Buyers Don’t Know About and Claim the New $6,000 Senior Tax Deduction on Schedule 1-A Before You File
This article is for general informational purposes and is not tax or legal advice. For guidance specific to your situation, consult a licensed tax professional or refer to official IRS guidance.