New Federal Tax Deductions for Tips and Overtime Income (2025–2028)

Effective at the top of this year (2025), newly enacted legislation modifies the federal income tax treatment of certain tip and overtime earnings. Rather than remaining fully taxable as before, eligible employees may qualify for temporary income tax deductions on these types of income through 2028.

 

Tip Income Deduction

From 2025 through 2028, eligible employees may deduct up to $25,000 of qualified tip income annually. This deduction is phased out for individuals with a modified adjusted gross income (MAGI) exceeding $150,000, or $300,000 for those filing jointly as married couples.

The deduction is available to workers in occupations designated by the IRS as tip-eligible.

According to a draft list published by the Treasury Department, these roles include traditional service positions, as well as occupations such as plumbers, electricians, HVAC installers, digital content creators, and home movers.

Certain industries are not included. Professionals employed in health care, law, accounting, financial services, and investment management are specifically excluded from eligibility.

Qualified tips may consist of cash, credit card payments, or proceeds distributed via tip-sharing arrangements. The deduction can be claimed irrespective of whether the taxpayer itemizes deductions. Both employees and self-employed individuals may qualify for this benefit.

Overtime Income Deduction

From 2025 to 2028, workers can deduct up to $12,500 of qualified overtime income annually ($25,000 for joint filers). The deduction phases out at the same MAGI thresholds and applies regardless of itemizing. Qualified overtime income means the extra half of “time-and-a-half” pay under Section 7 of the FLSA; it excludes state-mandated premiums, collective agreements, or tip income.

Payroll Tax and Reporting Considerations

These provisions are deductions, not exclusions. This means qualified tip and overtime income may still be subject to federal payroll taxes and could remain fully taxable at the state or local level. Federal income tax withholding rules also continue to apply.

Accurate reporting is essential so workers can claim the deductions.

• Tip income must be reported on Form W-2, Form 1099-NEC, or another designated information return provided to both the worker and the IRS.

• Overtime income must be reported on Form W-2 or another specified return.

  
  

IRS Guidance

For the 2025 tax year, the IRS has indicated there will not be changes to federal information returns (Forms W-2, 1099, 941, etc.) or income tax withholding tables. Updates are expected for the 2026 tax year.

Employers and payroll providers should begin recording qualified tip and overtime income, including amounts from earlier in 2025. The IRS has announced that transition relief will be available for the initial year.