Key Takeaways
- Tip and overtime income may be deductible on individual tax returns, with deductions retroactive to January 1, 2025, and expiring December 31, 2028.
- Payroll tax withholding for overtime and tips remain unchanged; employees claim deductions when filing their returns.
- Income thresholds apply for eligibility and phase-out limitations; qualified overtime is defined by the Fair Labor Standards Act.
The new tax legislation is a significant change for both individuals and businesses.
During a recent webinar about the new bill, we received several questions about overtime pay and tips.
Here’s what you need to know.
No Tax on Tips
Under the new legislation, qualifying tip income may be deductible on individual tax returns — offering potential tax relief for employees in tipped roles. But many details around withholding and eligibility still need clarification.
Q: Is the tip deduction effective for CY2025 (retroactive to January 1)?
- A: Yes, this deduction is retroactive to January 1, 2025, and expires on December 31, 2028.
Q: Regarding tips, does this mean that tax withholding remains in place, and the deduction results in either a lower tax burden or higher refund upon filing?
- A: Employers will still withhold payroll taxes upon paying the employee and identify on the W2 qualified tips for the taxpayer to claim the deduction on their individual tax return.
Q: Is the tip income exclusion limited only to those employees that are paid a sub-minimum wage?
- A: The tip income deduction is available to qualified workers regardless of their direct wages. However, this deduction does phase out for those with modified adjusted gross income over $150,000 ($300,000 for joint filers).
Q: What is the effective date of the change in FICA tip tax credit, which is now eligible for the beauty salon industry?
- A: This employer only deduction is retroactive to January 1, 2025.
Combined Questions on No Tax on Tip and Overtime
While the new deductions for tips and overtime offer potential savings for employees, they don’t alter payroll tax withholding processes — at least not yet. Employers and payroll providers will still play a key role in reporting, while individuals claim deductions when filing their returns.
Q: If there is no tax on tips and overtime, aside from reporting these amounts on an employee's W-2, do employers continue to withhold taxes on tips and overtime as before, and then employees address this on their personal tax returns?
- A: Employers will continue to withhold payroll taxes on all overtime and tips. Taxpayers are responsible for deducting the amount on their individual tax returns.
Q: With the "no tax" on tips and overtime, what will change for payroll processing? Or is it just 1040 deductions?
- A: Software companies are working on how to easily identify the qualified tips and overtime premium for W-2 reporting. The IRS is still working on how they will update and change Form W-2. Employers will still withhold all taxes on employees’ paychecks for overtime and tips. Taxpayers are responsible for deducting the amount on their individual tax returns.
No Tax on Overtime
Employees who earn qualified overtime pay may now be eligible to deduct that income on their personal returns, creating a new opportunity for tax savings. The deduction comes with income thresholds and applies to specific types of overtime compensation.
Q: Is the overtime deduction effective for CY2025 (retroactive to January 1)?
- A: Yes, this deduction is retroactive to January 1, 2025, and expires on December 31, 2028.
Q: Can a couple take deductions for overtime pay and tips if both husband and wife work separate jobs that qualify, and they meet income thresholds?
- A: Eligible individuals are provided a deduction up to $12,500 ($25,000 for joint filers) for qualified overtime compensation. For qualified tips received, eligible individuals are provided a deduction of up to $25,000. This amount does not go up for joint filers.
Q: Does the deduction for extra pay for overtime apply for all jobs or only a select few?
- A: Qualified overtime compensation is overtime compensation paid to an individual required under the Fair Labor Standards Act of 1938 (FLSA) that is in excess of the regular rate.
Q: Do we know if/how the overtime deduction will be applied to salaried overtime workers such as tax accountants?
- A: Qualified overtime compensation is overtime compensation paid to an individual required under the Fair Labor Standards Act of 1938 (FLSA) that is in excess of the regular rate.
Q: Will the Form W-2 be updated?
- A: Yes, the IRS will provide guidance later.
Q: Is OT pay deduction limited by AGI?
- A: The amounts allowed as a deduction will be reduced by $100 for each $1,000 an individual earns above an adjusted gross income of $150,000 ($300,000 for joint filers).
Q: Is the no tax on overtime only benefiting employees or the employer as well?
- A: The employee will receive the deduction reported on their individual tax return.
Q: For those currently paid as salary, does it make sense to change to hourly with OT?
- A: We recommend seeking legal guidance on this answer to determine The Fair Labor Standards Act (FLSA) rules on exempt vs non-exempt employee status.
Q: Could you please tell me more about the new employee tax benefits for overtime?
- A: The exemption applies only to the overtime premium. Employers will still withhold all taxes upon paying the employee. Form W-2 will be adjusted to identify the amount for overtime premium separately. Taxpayers are responsible for deducting the amount on their individual tax returns.
Q: How will we see these credits affect how we handle the accounting on these credits?
- A: This is an employee credit, and no accounting will be needed.
What Comes Next
As with any new tax law, the IRS is still working on guidance and updated forms, and employers should monitor updates to ensure compliance.
We’ll continue to provide updates as implementation details emerge.
Stay Up to Date
Tax
We have the tax expertise to meet your business needs.
Who We Are
Eide Bailly is a CPA and business advisory firm helping our clients grow, thrive, and embrace opportunities and innovation.
