Recent headlines claiming overtime pay and tips are now “tax-free” can be misleading. In reality, a 2025 law often called the One Big Beautiful Bill Act (OBBBA) made targeted tax changes that allow new deductions for overtime and tip income, but they are not completely tax-free.
How Overtime Is Treated Under the New Law
Before this law, all overtime pay was taxed the same as regular wages. Under the new rules, workers can now take a special deduction for the overtime premium portion of their pay, meaning only the extra amount earned for working overtime qualifies.
For example, if your regular rate is $20 per hour and your overtime rate is $30 per hour, only the extra $10 per hour may be deducted. Your base pay is still fully taxable.
The deduction is capped at $12,500 per year for single filers and $25,000 for joint filers. It applies to tax years 2025 through 2028 and begins to phase out for higher-income earners. Importantly, overtime wages must still be reported in full on your tax return.
How Tip Income Is Treated
Tips have always been considered taxable income, and that hasn’t changed. However, workers in jobs that customarily and regularly receive tips (such as servers, bartenders, and delivery drivers) may now deduct up to $25,000 in qualified tip income per year from their federal taxable income.
This deduction is available whether you itemize deductions or take the standard deduction, but it also phases out at higher income levels. Employers are required to report tip income so workers can properly claim the deduction. Note that self-employed individuals are also eligible for this deduction.
What This Means for Workers
If you earn tips or regularly work overtime, these deductions may lower your federal income tax and allow you to keep more of your earnings. However:
- The changes are temporary and scheduled to expire after 2028 unless extended
- All tip and overtime income must still be reported to the IRS
- These deductions do not apply to payroll taxes like Social Security and Medicare
In short, the law provides temporary tax relief through deductions, not a full tax exemption for overtime and tip income.
As always, each individual’s tax situation is unique, and we encourage you to consult with your tax professional for how this can apply to you. Please don’t hesitate to reach out to our office if you have any questions!
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