The One Big Beautiful Bill Act (OBBBA) took effect in 2025, creating flashy new deductions for “no tax on tips” and “no tax on overtime.” In reality, these are above-the-line tax deductions, not exclusions, and they come with strict limits. For 2025–2028, eligible workers can deduct qualified tips (up to $25,000) or qualified overtime (up to $12,500 per individual). Importantly, these amounts remain subject to normal payroll taxes (Social Security/Medicare), phase out at $150,000 MAGI ($300,000 joint), and must be claimed on individual returns. The IRS has begun issuing guidance (e.g. Notice 2025-69) to help taxpayers compute these deductions for 2025, but many administration details – including new forms and regulations – are still in flux. Employers and employees alike need to understand the rules to take full advantage of these benefits without tripping over the requirements.

Section 224: “No Tax on Tips”

OBBBA §224 allows a deduction for qualified tips received in tax years 2025–2028. Only tips earned in occupations that “customarily and regularly” received tips before 2025 qualify. The Treasury and IRS have published a preliminary list of eligible occupations (grouped into eight categories such as Beverage & Food Service, Entertainment, Hospitality, Home Services, etc.). For example, servers, bartenders, delivery drivers, hair stylists, personal trainers, and many gig-economy roles are covered.

However, qualifications are strict. A “qualified tip” must be voluntary cash or charged tips paid by a customer (including amounts from tip-sharing pools). Mandatory service charges or auto-gratuities do not qualify. In fact, Littler LLP notes that anything “paid voluntarily, without consequence for nonpayment,” qualifies, meaning employees should not claim deductions on automatic fees imposed by the employer. The tip must be reported either on the Form W-2 (box 7 “Social security tips”) or, for contractors, on a 1099 (or Form 4137 if self-reported).

Another important restriction is the Specified Service Trade or Business (SSTB) carve-out. Tips received in certain high-skilled fields – health care, law, accounting/consulting, performing arts, athletics, etc. – are not deductible. Until final guidance is issued, IRS Notice 2025-69 provides temporary relief: an employee in a listed tipped occupation (e.g. a bartender in a theater) is treated as not working in an SSTB for 2025. This transition rule is intended to give employers and workers time to adjust; future regulations may tighten the SSTB rules.

Key facts about the tip deduction:

  • Maximum deduction: $25,000 per taxpayer per year. For self-employed individuals, the deduction cannot exceed their net income from the tipped business.
  • Phase-out: Begins at $150,000 MAGI ($300,000 joint).
  • Eligible payments: Cash or card tips from customers, including amounts received via tips pools. Non-cash gifts or mandatory service fees do not count.
  • Eligible workers: Those in occupations on the IRS list (e.g. servers, bartenders, bellhops, valet attendants, hair and spa service providers, coaches/instructors, ride-share drivers, etc.).
  • Excluded businesses: Tips earned in an SSTB are disallowed.
  • Reporting: Ultimately, employers must report total cash tips in Box 12 (code “TP”) on the 2026 (and later) W-2s, and include the employee’s Treasury Tipped Occupation Code in a new Box 14b. (For 2025 only, employers were not required to change forms, but IRS notice 2025-62 gives them penalty relief if they didn’t separately account for tips.)

Section 225: “No Tax on Overtime”

Section 225 parallels the tip deduction for overtime pay. It allows an above-the-line deduction for qualified overtime compensation in 2025–2028. “Qualified overtime” is defined as the overtime premium required by the Fair Labor Standards Act (FLSA) – essentially the “half” portion of time-and-a-half pay. Only FLSA-mandated overtime qualifies; any overtime paid under state law or collective bargaining beyond FLSA requirements does not qualify. For example, if an employee’s overtime rate is $30/hour versus $20/hour regular, only the extra $10/hour counts toward the deduction.

The overtime deduction is capped at $12,500 per taxpayer ($25,000 for joint filers) and phases out above the same $150k/$300k thresholds. Importantly, this deduction is above the line, so it can benefit both itemizers and non-itemizers. The law expressly prohibits “double dipping”: any overtime pay that was already counted as a tip does not get counted again.

Key facts about the overtime deduction:

  • Definition: Only the FLSA-required overtime premium (the amount above the regular rate). If an employer pays double-time voluntarily, only the portion above 1.5× regular rate counts.
  • Maximum deduction: $12,500 per filer per year ($25k joint).
  • Phase-out: Begins at $150,000 MAGI ($300,000 joint).
  • Exclusions: State-law overtime beyond FLSA does not qualify. Tips are also excluded from this count.
  • Reporting: Employers will eventually need to report the overtime premium in Box 12 (code “TT”) on the W-2. For 2025, separate reporting wasn’t required, and relief from penalties was provided, but going forward the overtime must be tracked distinctly.

Compliance and Payroll Reporting

These deductions put a premium on accurate payroll accounting. Starting in 2026, employers must modify W-2 reporting: Box 12 code TP will show the total qualified tips reported, and Box 12 code TT will show total qualified overtime premiums. Box 14 has been split into 14a and 14b, with Box 14b reserved for the Treasury Tipped Occupation Codes. Employers should update their payroll systems now to capture these amounts and the corresponding occupation codes (each job is assigned a 3-digit code on the IRS list).

For tax year 2025, the IRS provided transitional relief: no penalties for failing to separately account for tips or overtime. Nevertheless, employers were encouraged to compile and share approximate tip and overtime figures with employees. For example, ADP notes that employers could use any reasonable method (point-of-sale records, tip logs, etc.) to estimate 2025 tip and overtime amounts and relay them (via paystubs or secure portals) to help employees claim the deductions. This practice remains voluntary but advisable: clear reporting will make it easier for tipped and overtime workers to claim their deductions on the 2025 return. Similar guidance applies for payments to contractors (Form 1099); again, separate reporting of qualifying tips/overtime will be required starting in 2026.

Action steps for employers:

  • Audit systems now. Ensure payroll software can record qualified tips and overtime separately and output the new W-2 codes TP/TT and Box 14b occupation codes.
  • Collect 2025 data. Even though 2025 forms aren’t changing, gather any records of cash tips and overtime premiums now so employees can claim deductions.
  • Educate HR/payroll. Train staff on which roles and payments qualify (e.g. review the IRS occupation list and tip/overtime definitions). Make sure employees know they should claim these deductions.
  • Watch for guidance. Final regulations are still coming (public comments closed Oct. 2025 on the occupations list). Stay tuned for IRS or Treasury updates, and update policies once official rules are issued.
  • Consult advisors. Because the rules intersect with wage classification and 199A SSTB rules, seek legal/tax advice to navigate ambiguities and avoid unintentional misclassification.

In short, the “no tax on tips/overtime” rules offer real benefits, but only if employers and workers follow the new procedures. Employers should proactively adjust payroll processes, provide clear recordkeeping, and guide employees on how to claim the deductions.