H.R. 1 (the Act), formally known as or nicknamed the “One Big Beautiful Bill Act”, was signed into law on July 4, 2025, and addresses the often-mischaracterized tax deduction for tips and overtime pay. Tips and overtime pay are not tax-exempt. Instead, the bill allows employees to claim deductions and creates new recordkeeping obligations for employers.
Tip Deduction
When does the tip tax deduction take effect, and for how long?
The deduction is available for tax years beginning on or after January 1, 2025, through December 31, 2028.
Which workers qualify for the tip tax deduction?
Employees working in occupations where tipping is customary may qualify, including tips paid in cash, by card, or under a tip-sharing arrangement. To claim the deduction, workers must provide their Social Security number on their tax return. Married workers must file jointly if eligible.
The Treasury Department recently published a preliminary list of occupations that regularly and customarily receive tips. The final list will be included in forthcoming regulations.
What is deductible under the tip tax deduction provisions?
Qualifying workers may deduct up to a maximum of $25,000 in tips received from customers. The maximum tip deduction is reduced by $100 for every $1,000 over $150,000 that the employee earns in modified adjusted gross income (or for every $1,000 over $300,000 in income for joint filers).
Qualifying tips are those given voluntarily by the customer. Tips negotiated in advance do not qualify. Tips earned in certain specified services, trades or businesses are excluded. Additionally, under the proposed rule, automatic service charges may not qualify for the deduction. “For instance, in the case of a restaurant that imposes an automatic 18% service charge for large parties and distributes that amount to waiters, bussers, and kitchen staff; if the charge is added with no option for the customer to disregard or modify it, the amounts distributed to the workers from it are not qualified tips.” See IRS guidance. Businesses involved in investing, trading, or dealing in securities, partnership interests, or commodities are also excluded.
How does the tip tax deduction impact employers?
Employers must provide a separate accounting of workers’ tips from their regular wages. These records must be provided to the IRS and reflected on employees’ W-2s or contractors’ 1099s. For 2025 only, employers may approximate cash tip accounting using any reasonable method allowed by the Treasury Department.
In addition, deductible tips are excluded from qualified business income for reporting purposes. Beauty service employers, including hair, nail, barbering, spa, and esthetics businesses, may now take advantage of the FICA tax tip credit for their tipped employees. Previously, only food and beverage employers were eligible.
Overtime Deduction
When does the overtime deduction take effect, and for how long?
The deduction is available for tax years beginning on or after January 1, 2025, through December 31, 2028.
Which workers qualify for the overtime tax deduction?
Non-exempt workers covered by the federal Fair Labor Standards Act (FLSA) who must receive overtime pay for all hours worked beyond 40 in a week may qualify. Overtime must be paid at one and a half times the regular rate of pay.
Exempt employees under the FLSA, such as executives, administrators, and professionals, are not eligible. To claim the deduction, workers must provide their Social Security number. Married workers must file jointly to qualify.
What is deductible under the overtime deduction provisions?
Up to $12,500 of qualified overtime compensation is tax-deductible, or up to $25,000 for joint filers. As with the tip deduction, the maximum overtime deduction is reduced by $100 for every $1,000 over $150,000 that the employee earns in modified adjusted gross income (or for every $1,000 over $300,000 in income for joint filers).
How does the overtime deduction impact employers?
Employers must file separate accounting for qualified overtime pay apart from regular wages. This must be reflected on employees’ W-2s. Many employers will need to adjust payroll and record-keeping systems.
Next Steps
The IRS is expected to issue regulations and further guidance, which may add exclusions or new requirements. The IRS has released a draft W-2 reflecting some of these changes.
If you have questions about how these changes may impact your business or need assistance navigating the new deductions or other changes under the Act, contact your Varnum attorney or a member of our Labor & Employment Practice or Employee Benefits Practice Teams.
