On July 4, 2024, President Trump signed the “Big Beautiful Bill,” which contains two provisions that provide federal income tax deductions on both tips and overtime compensation beginning January 1, 2025, through December 31, 2028.
New Deduction on Qualified Tips
Effective for the years 2025 through 2028, employees and self-employed individuals may be eligible for a new federal income tax deduction for qualified tips received in occupations that the IRS identifies as “customarily and regularly receiving tips” on or before December 31, 2024. Qualified tips include voluntary cash or charged tips received directly from customers or through tip-sharing arrangements, and must be filed on a Form W-2, Form 1099, or directly by the individual on Form 4137.
The deduction is subject to an annual cap of $25,000. For self-employed individuals, it may not exceed the net income derived from the applicable trade or business, calculated without regard to this deduction. The benefit phases out for taxpayers with modified adjusted gross income over $150,000, or $300,000 for joint filers, and is available to both itemizing and non-itemizing taxpayers. However, individuals engaged in a Specified Service Trade or Business (SSTB) under section 199A and employees whose employers are in an SSTB are not eligible.
To claim the deduction, taxpayers must file jointly if married and include their Social Security Number (SSN) on their return. Employers and other payors will be required to file information returns with the IRS or the Social Security Administration (SSA) and furnish statements to recipients that disclose the amount of cash tips and the recipient’s occupation.
The IRS is expected to issue a list of eligible tip-receiving occupations by October 2, 2025 and provide transition relief for taxpayers and payors during the 2025 tax year.
What Employers Should Know About New Deduction on Qualified Tips
Employers have important new reporting obligations under the tip deduction provision. Employers must accurately report both cash and non-cash tips received by employees, along with each employee’s occupation, on their annual Form W-2. For independent contractors who receive tips, businesses are required to file separate information returns, such as Form 1099, that reflect the total tipped amount and clearly indicate the recipient’s occupation.
It is important to note that Social Security and Medicare taxes, commonly referred to as FICA (Federal Insurance Contributions Act) taxes, remain applicable to all reported tips. The Social Security tax funds retirement, disability, and survivor benefits. Meanwhile, the Medicare tax supports hospital insurance for individuals aged 65 and older. Both the employer and the employee contribute equal shares of these taxes on all wages, including tips. Employers must continue to withhold and pay these taxes in accordance with existing law.
Additionally, the FICA tip credit, which was historically limited to food and beverage establishments, has been expanded to include employers in the beauty and personal care industries, such as salons and spas. However, to be eligible for the FICA tip credit, tipping must be customary and regular within the scope of the business. Employers in these newly included industries should assess their tipping practices and ensure compliance with both the reporting and tax obligations associated with this credit.
Practical Steps for Employers: Tips Deduction
Employers and management will want to consult with legal counsel to consider the following actions:
- Identify covered occupations
Monitor IRS guidance to determine which occupations are considered to “customarily and regularly” receive tips as of December 31, 2024. Employers should begin documenting which employees fall within these categories.
- Update payroll and reporting systems
Ensure payroll software can separately track and report both cash and non-cash tips, and associate each with the employee’s occupation. This will be essential for accurate Form W-2 reporting.
- Enhance tip reporting procedures
Reinforce procedures for employees to report tips accurately and consistently. This may include periodic training or requiring tip declarations at regular intervals.
- Prepare for expanded Information return requirements
If paying tipped independent contractors, develop a system to capture and report tip amounts and occupations on Form 1099 or another IRS-approved statement.
- Maintain compliance with FICA tax obligations
Continue withholding and remitting Social Security and Medicare taxes on all tips, as FICA obligations remain unchanged by the new deduction.
- Assess FICA tip credit eligibility
For employers in beauty, personal care, and similar industries, evaluate whether tipping is customary and regular to determine potential eligibility for the expanded FICA tip credit.
- Monitor IRS transition relief and future guidance
Stay alert to upcoming IRS publications, including the expected occupation list by October 2, 2025, and any transition relief applicable to tax year 2025.
Federal Deduction on Overtime Compensation
Effective for the years 2025 through 2028, eligible individuals may claim a federal income tax deduction for qualified overtime compensation received in excess of their regular rate of pay. This includes the “premium” portion of overtime, such as the additional half-time amount paid under the Fair Labor Standards Act (FLSA) as part of “time-and-a-half” compensation. The deduction does not apply to any overtime wages paid in addition to those required under the FLSA, such as agreements to pay double overtime (sometimes found in collective bargaining agreements). Basically, the portion of overtime that is above the individual’s normal hourly pay is the portion that is eligible for the tax break on overtime pay. To qualify, the overtime compensation must be reported on a Form W-2, Form 1099, or another specified statement furnished to the individual.
The maximum deduction is $12,500 per year for single filers and $25,000 for joint filers. The benefit phases out for taxpayers with a modified adjusted gross income exceeding $150,000, or $300,000 for joint filers. The deduction is available to both itemizing and non-itemizing taxpayers. To claim the deduction, taxpayers must include their SSN on the return and, if married, must file jointly. Employers and other payors are required to report the total amount of qualified overtime compensation paid during the year to both the IRS (or SSA) and the recipient.
The IRS will issue transition relief for tax year 2025 for both taxpayers and reporting entities to help implement the new deduction and associated filing obligations.
What Employers Should Know About Overtime Compensation Deduction
Although the new federal deduction for overtime compensation is claimed by individual taxpayers, employers have important responsibilities in supporting accurate reporting. Specifically, employers must identify and track the portion of overtime pay that qualifies for the deduction, which is the premium amount paid above the employee’s regular rate under the FLSA. Accurate payroll records are essential, as incorrect reporting may limit an employee’s ability to claim the deduction or lead to compliance issues.
Employers will be required to report the total amount of qualified overtime compensation paid to each employee on annual wage statements such as Forms W-2 or 1099. These forms must reflect the correct amounts and be submitted to the IRS or SSA and the employee. Employers should begin reviewing their payroll systems, verifying SSN records, and preparing for updates to reporting formats.
In addition, employers should monitor IRS guidance regarding implementation and transition relief for the 2025 tax year. Consulting with legal and tax professionals can help ensure reporting practices align with the new requirements. Clear communication with employees about how overtime is calculated and reported will also support a smooth transition.
Practical Steps for Employers: Overtime Compensation Deduction
Employers and management will want to consult with legal counsel to consider the following actions:
- Review overtime pay practices
Ensure all overtime compensation complies with the FLSA and is clearly documented. Only the “premium” (e.g., the additional half-time pay) portion of time-and-a-half wages is deductible by employees.
- Configure payroll to track overtime premium separately
Adjust payroll systems to distinguish between regular wages and the overtime premium amount. This will support proper reporting and help employees claim the deduction.
- Prepare for new reporting requirements
Employers must furnish annual statements (e.g., Form W-2 or Form 1099) that clearly reflect the total amount of qualified overtime compensation paid to each worker.
- Verify SSN collection
Since employees must include their SSN to claim the deduction, employers should ensure accurate SSN records are maintained and verified for all employees.
- Coordinate with tax and legal advisors
Engage internal or external tax counsel to ensure that pay structures and recordkeeping comply with evolving IRS guidance and that reporting formats meet new requirements.
- Communicate with employees
Provide employees with clear documentation and guidance to support their ability to claim the deduction, including properly labeled wage statements.
- Monitor IRS updates
Stay informed about transition relief for tax year 2025 and any subsequent changes to reporting standards or eligibility rules.
