On July 3, 2025, Congress passed H.R. 1, the “One Big Beautiful Bill Act,” introducing two new above-the-line tax deductions for employees, one for “qualified tips” and the other for “qualified overtime compensation.” Both deductions take effect beginning with the 2025 tax year and are set to expire after December 31, 2028.
Though employees may welcome these deductions, they introduce new compliance, reporting, and administrative responsibilities for employers related to tip income and overtime.
Tip Income Deduction
Section 70201 allows employees to deduct up to $25,000 per year in “qualified tip” income which is reduced by $100 for each $1,000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return).
To qualify for the deduction tips must be voluntary, paid in cash or via card, and not required by the employer, and employees must work in a tip-eligible role as of December 31, 2024. The Treasury Secretary is expected to publish a list of qualifying roles.
Employers must report total cash tips and employee occupation on Form W-2. Tips must also be reported to the IRS via existing requirements (e.g., Form 4137). The IRS is working on new guidance and updated forms for the 2026 tax year.
Tips received for services in law, finance, consulting, and other excluded industries do not qualify.
Overtime Deduction
Section 70202 permits a deduction of up to $12,500 ($25,000 for joint filers) for “qualified overtime compensation” which is reduced by $100 for each $1,000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return).
The deduction applies to overtime premiums covered under the Fair Labor Standards Act (FLSA) qualify. The deduction does not apply to state-mandated or contractually agreed overtime not required by FLSA.
Employers will be required to report the overtime compensation on the employees’ W-2 separately.
Notably, compensation cannot be claimed under both the tip and overtime deductions.
Regulatory Guidance
The Internal Revenue Service (IRS) has provided affirmative but limited guidance related to new provisions as follows:
- Tax Deduction for Tips. The new tip deduction is effective for tax years 2025 through 2028 and can be claimed by a qualified individual, whether they itemize deductions. This deduction applies to occupations that the IRS lists as customarily receiving tips before December 31, 2024. The Treasury Department is expected to provide this official list by October 2, 2025.
- Overtime Tax Deduction. Also effective for tax years 2025 through 2028, individuals who receive qualified overtime compensation may deduct the amount of pay that exceeds their regular rate. This includes the “half” portion of “time-and-a-half” compensation that is required by the Fair Labor Standards Act (FLSA) and is reported on a Form W-2, Form 1099, or other specified statement.
Next Steps for Employers
To prepare for these changes, employers should:
- Review Pay Practices: Evaluate current compensation structures for compliance with federal and state wage and hour laws.
- Update Payroll Systems: Ensure systems can track and report qualified tips and overtime separately for W-2 reporting in 2025.
- Train HR and Payroll Staff: Provide training on eligibility criteria and new reporting obligations under H.R. 1.
- Monitor Regulatory Guidance: Await further clarification and guidance from the Treasury Department on definitions, compliance safeguards, and reporting methodologies, as well as updated forms.
