Tax season is coming up yet again, and there are some new laws you may need to be aware of. Here is what you need to know.

No Tax for Qualified Tips

For millions of Americans working in hospitality and other service industries, tips are a vital part of their income. Until now, tips were considered taxable income for federal tax purposes, and workers had to report them to the IRS and pay income tax. 

What’s Changed?

The new law allows up to $25,000 per year in tip income to be deducted from your taxable income for tax years 2025 through 2028. The deduction is not an exclusion from gross income, but a deduction when you file your tax return. This means you won’t see any withholding changes to your paycheck.

The deduction is NOT a full exclusion; tips still count toward Social Security and Medicare taxes. The deduction only applies to cash or card-based tips that you receive in qualifying jobs, but not to any service charges, regular wages or non-cash rewards

Example: At a restaurant, Sarah’s bill includes a 15% service charge automatically added because she is part of a large group. She pays the total with her credit card.  Even though it looks like a tip on the receipt, it’s a mandatory fee and not eligible for the tip income deduction. Her server is Jamal; therefore, Jamal cannot count the 15% service fee as a tip.

• The maximum deduction is $25,000 per year.
• Phaseout: the deduction is reduced by $100 for each $1,000 (or fraction thereof) by which the taxpayer’s modified adjusted gross income MAGI exceeds $150,000 ($3000,000) for joint filers.)

The deduction is only allowed for tips that are: 

• Included on a tax information form such as Form W-2, Form 1099 or similar. These are usually tips the employer records or that the employee reports to their employer, or
• Reported by the taxpayer on Form 4137 (Social Security and Medicare tax on unreported tip income)

Qualifying Occupations: The IRS will publish a list of occupations that customarily and regularly receive tips before the end of 2025. Examples likely include waiters, bartenders, hotel bellhops, casino dealers, hairdressers and other similar service roles. 

Other Requirements: The deduction is only available if the taxpayer includes their Social Security number on their tax return, and for married individuals, only if they file jointly.

Example: Maria is a waitress at the People’s Pig, a BBQ joint, which is a qualifying occupation. In 2025 she receives $30,000 in cash and card tips, all of which she reports to her employer and includes on her Form W-2. Her total income for the year is $70,000 ($30,000 for tips and the rest is regular wages). She is a single taxpayer. Because her MAGI is less than $150,000, Maria can deduct $25,000 of the $30,000 of tips on her tax return, making her adjusted gross income (before other deductions) $45,000 instead of $70,000.

No Tax on Overtime

Effective for 2025 through 2028, individuals who receive qualified overtime compensation may deduct the pay that exceeds their regular rate of pay, the “half” portion of “time-and-a-half” compensation, that is required for by the Fair Labor Standards Act (FLSA). The maximum annual deduction is $12,500 (or $25,000 if filing jointly) of qualified overtime pay. To take the deduction, you will need a Social Security number.

As the same with tips, this is NOT a total tax exemption; it’s a deduction for federal income tax only. Payroll taxes (Social Security and Medicare) still apply. Just as with the tips explained above, the deduction begins to phase out at $150,000 (MAGI) for individuals, and $300,000 for married taxpayers who file jointly. 

To qualify for this deduction an employer must report qualified overtime compensation separately on W-2s (the IRS will create a new box). Non-employees (e.g. contractors, but not self-employed individuals) must report the amount on Form 1099.

For tax year 2025 only, transitional rules allow employers to estimate this amount. We’re waiting for additional guidance from the IRS as to the exact definition of overtime. 

Example: Jane Doe is a regular employee who earns $60,000 in regular wages and $10,000 in qualified overtime pay in 2025. Her total income is $70,000. Under this provision:

• Jane can deduct the full $10,000 of qualified overtime pay from her taxable income at the end of the year.
• Her taxable income for federal purposes would include $60,000 of regular wages plus $10,000 of overtime,  totaling $70,000. However since the $10,000 is qualified overtime, she can claim a $10,000 deduction on her tax return. [$60,000 (regular wages) + $10,000 (overtime) – $10,000 (deduction for overtime)].

Taken from TaxBrief2025

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