New Tax Deductions Under the OBBBA: Tips, Overtime, and What Taxpayers Need to Know

The Opportunity for Better Budgeting and Benefit Allocation Act (OBBBA) introduces several groundbreaking provisions that directly impact working individuals. Two of the most attention-grabbing changes are the new deductions for tips and overtime pay. While the titles “no tax on tips” and “no tax on overtime” might suggest full exclusions from income, in reality, these changes create deductions, not exclusions. This means tips and overtime are still included in income and subject to Social Security and Medicare taxes, but taxpayers may deduct significant amounts from taxable income.

No Tax on Tips Deduction

For the 2025 through 2028 tax years, individual taxpayers can claim a deduction of up to $25,000 for qualified tips earned in occupations that traditionally and customarily received tips as of December 31, 2024. The Secretary of the Treasury must publish a list of qualifying professions within 90 days of the law’s enactment.

What Counts as Qualified Tips?

• Reported on W-2, 1099-K, 1099-NEC, or Form 4137.

• Voluntary payments determined by the customer (not mandatory charges).

• Not earned in a “specified service trade or business” (e.g., law, accounting, healthcare).

• Must meet any additional Treasury requirements.

Limitations

• Must have a valid Social Security number by the due date of the tax return.

• Married taxpayers must file jointly to qualify.

• For business owners, the deduction is limited to gross income from the trade/business (including tips) minus other business deductions.

Example

Kat runs a dog grooming business in 2025. She earns $100,000, including $20,000 in tips, but has $85,000 in expenses. Since her net income is $15,000, her tip deduction is capped at $15,000.

Phaseout

The deduction phases out at higher income levels:

• Begins at $150,000 MAGI ($300,000 MFJ).

• Reduced by $100 for every $1,000 above the threshold.

• Fully phased out at $400,000 MAGI ($550,000 MFJ).

Example: Stella earns $10,000 in tips but has $175,000 MAGI. Since she is $25,000 above the $150,000 threshold, her deduction is reduced by $2,500, leaving her with a $7,500 deduction.

No Tax on Overtime Deduction

For the 2025 through 2028 tax years, taxpayers can deduct up to $12,500 ($25,000 MFJ) for qualified overtime pay. Overtime is defined under the Fair Labor Standards Act of 1938 as hours worked over 40 in a week by nonexempt hourly employees.

Key Points

• Overtime must be separately reported on W-2s or 1099s.

• Employers are required to provide this separate reporting.

• Deduction available even if only one spouse earns overtime (when filing jointly).

Limitations

• Only available if taxpayers file jointly when married.

• Must have a valid Social Security number.

• Cannot double-claim—overtime pay cannot also be claimed as tip income.

Phaseout

• Begins at $150,000 MAGI ($300,000 MFJ).

• Fully phases out at $275,000 MAGI ($550,000 MFJ).

  
  

Employer Reporting Requirements

Employers must now:

• Report qualified tip income separately on W-2, 1099-K, or 1099-NEC.

• Report qualified overtime separately on W-2s (or 1099s for contractors).

• For wages earned before January 1, 2026, employers may use a reasonable approximation method to report qualified overtime.

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