Two new federal deductions changed how tips and overtime are taxed. Signed into law on July 4, 2025 as part of the One, Big, Beautiful Bill Act, they let millions of workers subtract part of their tip income and overtime premium from taxable income. The headlines call it “no tax on tips” and “no tax on overtime”, but the reality is more specific than that. These are income tax deductions with dollar caps and income limits, not a blanket exemption, and they do nothing to your Social Security and Medicare withholding. Here is what the rules actually say and how much they are worth.
What the tips deduction covers
If you work in an occupation that customarily and regularly receives tips, you can deduct qualified tips from your taxable income. The maximum deduction is $25,000 a year. It applies whether you take the standard deduction or itemize, which matters because most tipped workers do not itemize. For a self-employed person, the deduction cannot exceed the net income of the business in which the tips were earned.
Qualified tips are the voluntary amounts customers choose to leave, reported to your employer and shown on your Form W-2, or reported by a self-employed worker. Mandatory service charges added to a bill are not tips and do not count. The IRS maintains a published list of tipped occupations that qualify. The rules are laid out in the IRS guidance on the One, Big, Beautiful Bill Act.
What the overtime deduction covers
The overtime deduction is narrower than most people expect. You can only deduct the premium portion of your overtime pay, meaning the extra half in time-and-a-half. If your regular rate is $20 an hour and overtime pays $30, only the $10 premium counts, not the full $30. That premium must be the overtime required by the Fair Labor Standards Act and reported on your W-2.
The cap is $12,500 a year for a single filer and $25,000 for a married couple filing jointly. Like the tips deduction, it is available to filers who do not itemize.
The income limits both share
Both deductions start to shrink once your modified adjusted gross income (MAGI) passes $150,000, or $300,000 for joint filers. Above that line the deduction drops by $100 for every $1,000 of income over the threshold. That is a 10 percent taper. The tips deduction reaches zero at $400,000 of MAGI, and the overtime deduction phases out completely by $275,000 for a single filer ($550,000 joint). Married couples must file jointly to claim either one, and everyone claiming must include a valid Social Security number on the return.
Both deductions are temporary. They apply to the 2025 through 2028 tax years and expire after that unless Congress extends them.
Payroll tax still applies
This is the part the headlines skip. The deductions reduce federal income tax only. Your tips and overtime are still subject to the 6.2 percent Social Security tax and the 1.45 percent Medicare tax, and they still count toward your Social Security earnings record. Many states also tax the income normally, since a state has to pass its own law to match the federal change. So “no tax on tips” really means no federal income tax on up to $25,000 of tips, with FICA and often state tax untouched.
Worked example: a server with $18,000 in tips
Take a single server who earns $16,000 in wages and $18,000 in reported tips, for $34,000 total. Her tips sit inside the $25,000 cap, so she can deduct the full $18,000. After the 2026 standard deduction her income already falls in the 12 percent bracket, so deducting $18,000 cuts her federal income tax by about $2,160. Her Social Security and Medicare withholding does not change, because payroll tax was charged on the tips regardless. You can sanity-check bracket math with the percentage calculator, and estimate the full paycheck with the US paycheck calculator.
Worked example: overtime premium
A warehouse worker earns $28 an hour and logs enough overtime that the premium half adds up to $6,000 over the year. That $6,000 is under the $12,500 cap, so all of it is deductible. In the 22 percent bracket the deduction saves about $1,320 in federal income tax. Only the premium counted, not the base rate paid during those overtime hours. To see how the premium builds up from your hours, use the overtime pay calculator.
Frequently asked questions
Do I get the money back in my paycheck during the year? Not automatically. The deductions are claimed on your annual return, so for most people the benefit arrives as a smaller tax bill or larger refund after filing, not as bigger weekly pay. Your employer may adjust withholding, but the law does not require it.
Are service charges and automatic gratuities covered? No. A mandatory service charge, such as an automatic 18 percent added for large parties, is treated as wages, not a tip. Only voluntary tips left at the customer’s discretion qualify.
Does the deduction help if I already pay no federal income tax? Only up to the tax you owe. A deduction reduces taxable income, so if your income is already below the taxable threshold there is little or nothing extra to save. Lower earners often see a smaller dollar benefit than the caps suggest.
Is my state tax reduced too? Usually not, unless your state passes a matching law. Several states have chosen to keep taxing tips and overtime normally, so check your state revenue department before assuming the state portion drops.
What years does this last? The deductions apply for tax years 2025, 2026, 2027, and 2028. They expire after 2028 unless Congress renews them, per the IRS overview of the law.