Competing House and Senate bills have the potential to reshape how the IRS taxes tips and overtime wages. The Senate recently passed the “No Tax on Tips Act” while the House budget reconciliation bill proposes deductions for tip income and overtime wages.
Budget negotiations are only beginning, but employers should start tracking employee tip and overtime income now to prepare for the likelihood of future federal reporting requirements.
The Senate Tip Deduction
The Senate bill allows workers in tip-based occupations to deduct up to $25,000 in reported tip income each year, retroactive to Jan. 1, 2025. There is no expiration date on this bill as opposed to the House bill discussed below.
- What is a tip-based occupation? The Senate bill requires the IRS to identify qualifying occupations within 90 days of enactment.
- Who is eligible? The deduction in the Senate bill is available only to employees and not self-employed individuals. Employees must earn less than $160,000 in 2025, and the cap is indexed for inflation in future years. Lower-income tipped employees may not see much benefit: their income may already be below the filing threshold and the standard deduction in 2025 is $15,000. (The House budget reconciliation bill will increase that amount as well.)
- What qualifies for the deduction? Only tips reported to employers for payroll tax purposes qualify for the deduction. In general, this will include cash tips and tips paid via credit cards, but it will not cover in-kind tips, such as tickets, use of a car or other non-monetary tips.
- Payroll taxes remain: Tips will still be subject to Social Security and Medicare payroll taxes under the Senate bill, so both employees and employers must continue to report and withhold these taxes as usual. Employees who expect to qualify for the deduction, however, may adjust their W-4 forms.
- State taxes unaffected: The deduction in the Senate bill applies only to federal income tax. States will have to choose whether to conform to the new federal rule or maintain the current status. Tip income may remain taxable at the state level.
- Employer benefit: The Senate bill expands the existing Section 45B tip credit, which allows certain employers to claim a credit for payroll taxes paid on tips, to include more industries such as beauty and spa services.
The House Tip Deduction
The House bill allows workers in tip-based occupations to deduct all reported tip income, retroactive to Jan. 1, 2025, but it expires Dec. 31, 2028.
- What is a tip-based occupation? Tip-based occupation in the House Bill is the same as in the Senate bill, except the House bill requires the IRS to identify those industries in which tips were customarily earned prior to Dec. 31, 2024
- Who is eligible? The deduction in the House bill is available to both employees and self-employed individuals. Employees must earn less than $160,000 in 2025, and the cap is indexed for inflation in future years.
- What qualifies for the deduction? As with the Senate bill, only cash tips and tips paid via credit cards reported to employers for payroll tax purposes qualify for the deduction.
- Payroll taxes remain: Tips will remain subject to Social Security and Medicare payroll taxes under the House bill, so both employees and employers must continue to report and withhold these taxes as usual.
- State taxes unaffected: The deduction in the House bill also applies only to federal income tax, so states will have to decide whether to conform their income tax laws to federal law.
- Employer benefit: The House bill expands the existing Section 45B tip credit, which allows certain employers to claim a credit for payroll taxes paid on tips, to include more industries such as beauty and spa services.
Senate-House Comparison
Deduction Cap
- Senate: $25,000 per year.
- House: No explicit cap.
Covered Years
- Senate: Effective in 2025; no end date.
- House: Limited to 2025 through 2028.
Self-Employed Coverage
- Senate: Excludes self-employed individuals.
- House: Includes self-employed individuals.
Occupations Eligible
- Senate: Treasury to define, based on pre-2025 tipping custom.
- House: Same, but tied to industries accepting tips prior to Dec. 31, 2024.
Legislative Context
- Senate: Standalone bill; passed with unanimous consent.
- House: Part of the reconciliation bill; can pass the Senate with a simple majority, not subject to the filibuster.
House Overtime Pay Deduction
The bill allows employees to deduct 100% of “qualified overtime compensation” they receive in their 2025-2028 tax years.
- Above-the-line-deduction: Employees may deduct the full amount of qualified overtime compensation, regardless of whether they itemize or claim the standard deduction.
- Who is eligible? The deduction is only available to employees eligible for overtime under the Fair Labor Standards Act (FLSA) who earn less than $160,000 annually. The cap is indexed for inflation.
- What qualifies as overtime compensation? “Qualified overtime compensation” refers to the premium pay required under FLSA Section 7, meaning only additional pay for working more than 40 hours per week. As such, overtime pay earned under state law or by contract for working more than a certain number of hours in a day is not deductible.
- Reporting requirements: Employers must report the total amount of qualified overtime compensation on Form W-2. The IRS is expected to provide guidance and possibly adjust withholding tables to reflect the deduction.
- Payroll taxes remain: Overtime pay will still be subject to Social Security and Medicare payroll taxes for employees and employers.
A Final Note
Both bills attempt to provide tax relief for workers, but their overall benefits and requirements vary by occupation, income level, and state. Employers and employees should prepare for significant administrative changes in anticipation of these new laws and remain alert for further federal and state guidance. In addition, employers should begin tracking and reporting tip and overtime pay now, to support employee deductions and employer credits dating back to January 1.
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