No tax on tips and overtime: What employers should know

Executive summary

This article, originally published June 2, 2025, has been updated to reflect that the One Big Beautiful Bill Act was signed into law on July 4, 2025.

Provisions titled “No tax on tips” and “No tax on overtime” were enacted as part of the One Big Beautiful Bill Act, which was signed into law on July 4, 2025. The provisions create new individual income tax deductions for qualified tips and overtime pay. Employers will need to consider wage eligibility, reporting requirements, and implications for payroll administration.

• The “No tax on tips” and “No tax on overtime” provisions authorize eligible individual workers to deduct qualified tips and overtime pay from their federal taxable income for 2025–2028, but Social Security and Medicare taxes still apply. Thus, employers will still have to withhold employment taxes for their employees who receive tips or overtime.
• Employers must continue to report tips and overtime compensation on Form W-2, though there are new requirements to separately identify tips and overtime amounts for tax reporting purposes.
• Payroll systems may need to be updated, including for new withholding tables and to track overtime.

Provisions to reduce taxes on tips and overtime, which became law on July 4, 2025 as part of the One Big Beautiful Bill Act (OBBBA), affect employers’ reporting requirements and could necessitate updated payroll systems. The provisions take effect retroactively, starting at the beginning of 2025 and expiring at the end of 2028. Both provisions have implications for employers, including, for example, with respect to wage eligibility, reporting requirements, and payroll administration.

No tax on tips

The tips provision, titled “No tax on tips,” is not limited to tips received solely by employees (nonemployees can also receive the benefit), but it does present unique considerations for employers. Effective for tax years 2025 through 2028, individuals can exclude qualified tips from gross income for federal income tax purposes. The exclusion would be taken by the individual as an above-the-line deduction on their federal income tax return. The deduction is capped at $25,000 and phased out by $100 for each $1000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return).

Qualified cash tips include tips received from customers that are paid in cash or are charged and, in the case of an employee, tips received under any tip sharing arrangement. Additionally, only tips received in an occupation that customarily receives tips, as identified by the Secretary of the Treasury within 90 days of the effective date of the provision (i.e. by early October), are considered to be qualified tips. Tips are still wages for Federal Insurance Contribution Act (FICA) tax purposes, meaning they are still subject to social security and Medicare tax.

Employees can only deduct tips that are reported on certain information returns, such as Form W-2, Wage and Tax Statement. Beginning in 2025, employers must report tips and the occupation of the person receiving the tips  in order to comply with the reporting requirements.

What does this mean for employers?

• Tips still have to be reported. As applicable, tips must still be reported by employees to their employers and reported by employers to their employees on Form W-2.

• Tax withholding is still required. The tips provision does not create an exclusion from income subject to withholding. Tips remain subject to federal income tax withholding (and state and local tax withholding where applicable), as well as employment tax withholding, including Social Security and Medicare taxes.

• Payroll systems and information may need to be updated. Given retroactivity of the provision to the start of 2025, payroll systems may need to be configured quickly to reflect updated withholding tables or updated Forms W-4, Employee’s Withholding Certificate, received in anticipation of reducing taxable income for tips. However, while the “No tax on tips” rule is effective beginning Jan. 1, 2025, the benefit is claimed on a taxpayer’s individual income tax return, and retroactive systems modifications are not mandated as long as an employer can otherwise comply with the law.

• Form W-2 reporting will likely change only minimally. Tips are currently reported on Form W-2 as follows:

  • Box 1: Wages, tips, and other compensation
  • Box 5: Medicare wages and tips
  • Box 7: Social Security tips (summed with Box 3, these numbers should not exceed the Social Security wage base ($176,100 for 2025))
  • Box 8: Allocated tips from large food or beverage establishments

Employers are required to separately identify total tips reported by employees on Form W-2 along with the occupation of the person receiving the tips. Employers already report most tips separately on their employment tax information return (typically Form 941, Employer Quarterly Federal Tax Return Lines 5b (Social Security tips)).

Additionally:

• Service charges, such as an 18% automatic gratuity for large parties at restaurants, are not tips.
• Tips that are not reported by employees to their employer may still be deductible if employees report them on Form 4137.
• For nonemployees receiving tips, there is currently no specific reporting line for tips on Form 1099-NEC, Nonemployee Compensation (and some employers may not have much information about tips paid to self-employed individuals). However, the provision requires Form 1099 reporting of tipped amounts and an indication of whether they are received in a customarily tipped occupation.  Although it is not clear, it appears that non-employees will still have to pay self-employment taxes on the tips received.

No tax on overtime

The overtime provision, titled “No tax on overtime,” applies to both employees and nonemployees, though it appears the provision will largely apply to employers paying qualified overtime to employees. The provision allows certain eligible employees to take a deduction for overtime wages paid pursuant to the Fair Labor Standards Act of 1938 (FLSA) and reported on Form W-2.

Similar to the tips provision, effective for tax years 2025 through 2028, employees can exclude qualified overtime compensation from gross income for federal income tax purposes. The exclusion would be taken by the individual as an above-the-line deduction on their federal income tax return. The deduction is capped at $12,500 for single filers and $25,000 for joint filers and phased out by $100 for each $1000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return). Qualified overtime compensation is defined by reference to the Fair Labor Standards Act (FLSA). Overtime is still wages for FICA tax purposes, meaning the wages are still subject to social security and Medicare tax.

Individuals can only deduct overtime that is reported on certain information returns, such as Form W-2. Currently, overtime pay is not identified separately from regular wages on Form 941 or Form W-2. For 2025, employers can approximate a separate accounting of amounts designated as tips and overtime by any reasonable method “specified by the Secretary” in order to comply with the reporting requirements.

What does this mean for employers?

• Tax withholding and reporting of employee compensation is still required. As with the tips provision, the overtime provision does not create an exclusion from income subject to withholding. Overtime wages are still required to be reported to employees on Form W-2. Overtime wages are still subject to federal income tax withholding (and state and local tax withholding where applicable), as well as employment tax withholding, including Social Security and Medicare.
• Payroll systems may need to be updated. Payroll systems likely already track overtime wages for purposes other than tax, but new software mapping may be required to also capture overtime wages for purposes of satisfying the requirements of the overtime provision. Typically, vendors require time to bring systems up to date and, given that the provision is retroactive to the beginning of 2025, this could present a transition period with administrative complexities. Some of this burden will likely be relieved by the transition rule for 2025.
• Overtime wages need to be identified on Form W-2. Employers will be required to report overtime wages separately on Form W-2. This could be accomplished through new Box 12 or 14 reporting. It is unlikely that reporting on Form W-2, Boxes 1, 3, and 5 would change.

Other considerations

• Interaction with federal labor laws: The FLSA regulates employment practices for employees that are classified as “nonexempt,” including the payment of wages and overtime. There are many categories of employees that are exempt from overtime under federal laws, including executive, administrative, professional and certain sales and certain computer-related occupations. The “No tax on overtime” provision relies on section 7 of FLSA to define overtime compensation that is eligible to be deducted under the provision; employers will have to understand both relevant federal labor laws and federal tax laws in order to determine qualified overtime.
• State and local impacts: The provisions address only the federal income tax treatment of tips and overtime; there is no change to state and local income taxation of tipped or overtime wages as a result of this legislation. Also, state overtime laws may be different from federal, and understanding how they interact is important for employers implementing these rules.
• The changes are temporary: The provisions are for calendar years 2025 through 2028; employers will need to consider the impact of the sunset.
• Employee communications: Employers may want to consider employee education on the provisions and communicating what changes, if any, employees can anticipate.
• Staying competitive: With recent inflation, spending power has declined, including for individuals that are eligible under the provisions. Employers with large groups of employees that earn tipped or overtime wages may want to ensure that payroll practices are up to date in order to comply with requirements and facilitate uptake by employees. Supporting eligible employees in their ability to take these deductions may help employers stay competitive in the marketplace and promote employee attraction and retention. Employers should consult with legal counsel and other appropriate professional advisors if they are considering making any changes to their employment or payroll practices.