The One Big Beautiful Bill Act created two deductions that reduce federal taxable income for workers who receive tips or overtime pay. Both are available for tax years 2025 through 2028, and both can be claimed whether or not the taxpayer itemizes. Neither removes the income from taxation entirely, which is the point most often misunderstood.
What the Deductions Cover
The tips deduction allows up to $25,000 of qualified tip income to be deducted annually. The figure is the same for single and joint filers. Qualified tips include amounts paid in cash, by credit card, or received through a tip-sharing arrangement.
The overtime deduction is capped at $12,500, or $25,000 for joint filers. Only the premium portion qualifies. In standard time-and-a-half pay, that means the extra half above the regular rate is deductible, not the full overtime amount. The overtime must also be required under Section 7 of the Fair Labor Standards Act. Premium pay owed under state law or a collective bargaining agreement, but not required by federal law, does not qualify.
Income Limits
Both deductions phase out above the same starting point: modified adjusted gross income of $150,000, or $300,000 for joint filers. The reduction is $100 of deduction for every $1,000 of MAGI above the threshold, or portion thereof.
Because the caps differ, the deductions disappear at different income levels. The tips deduction reaches zero at $400,000 of MAGI for single filers and $550,000 for joint filers. The overtime deduction, with its lower cap, reaches zero at $275,000 and $550,000 respectively.
A single filer with $20,000 of qualified overtime and MAGI of $175,000 is $25,000 over the threshold. The deduction is reduced by 25 increments of $100, or $2,500, leaving a deduction of $10,000 rather than the full $12,500.
Who Qualifies
The tips deduction applies to occupations the IRS has designated as ones where tipping was customary before December 31, 2024. Treasury has issued proposed regulations listing the qualifying occupations, which span food and beverage service, hospitality, personal appearance and wellness, and transportation and delivery, among others.
The deduction is available to both employees and self-employed individuals. It is not available to those earning tips in specified service trades or businesses, a category that includes health, law, accounting, financial services, and investment management. Married taxpayers filing separately cannot claim either deduction.
What These Deductions Do Not Change
Three points are worth emphasizing, because they are frequently misread.
First, payroll taxes still apply. Social Security and Medicare tax continue to be withheld on the full amount of tips and overtime, including the portion deducted for income tax purposes.
Second, state and local income tax treatment is unaffected. Income deducted federally may remain fully taxable at the state level, which matters in New York.
Third, the income must still be reported before it can be deducted. These are deductions against reported income, not exclusions from it.
Reporting and Transition Relief
Qualified tip income must be reported on Form W-2, Form 1099-NEC, or another specified information return furnished to both the worker and the IRS. Qualified overtime is reported on Form W-2 or a comparable statement.
For the 2025 tax year, the IRS provided transition relief. Employers and payors will not face penalties for failing to separately report qualified tips, qualified overtime, or occupation codes, provided the return is otherwise complete and correct. Updated forms take effect for the 2026 tax year, so employers should confirm their payroll systems are capturing the required detail going forward.
Documentation matters where reporting is incomplete. A worker whose Form W-2 understates tips may still substantiate the higher figure with a contemporaneous log showing dates and amounts.
Verma Tax can determine whether these deductions apply to your situation and confirm that your payroll reporting supports them. Contact us to review your circumstances before filing.