The holiday season is just around the corner. We are all getting ready to spend time with family and friends; cook a nice dinner; and see the smiles on children’s faces when they see the big floats in the Thanksgiving Day Parade, or good ol’ jolly Santa Claus. But that means that tax time is just upon us.
There are lots of changes in the tax code, due to the Trump Administration’s, “One Big Beautiful Bill Act (OBBBA),” that was enacted this year for the 2026 through 2028 tax years. Some aspects of the updated tax codes are retroactive back to the 2025 calendar year. The big elephant in the room, however, is this. These tax codes are only temporary through the next four tax years, and have to be re-examined before the 2029 tax year. Let’s break things down…
“No Tax on Tips”
The Qualified Tip Deduction is a plan that allows workers that rely on tips for a majority of their income to deduct a portion of it from their federal taxable income for the 2025 through.
2028 tax years. Eligible taxpayers may deduct up to $12,500 if they file single, or $25,000 annually per tax return if they file Married Filing Jointly. But which tips are eligible?
No Tax On Tips!
The tips must be considered a “Qualified Tip.” Those are tips that are voluntarily paid by the customer; for example, if a restaurant adds a 20-percent gratuity on a large table of diners, that tip would not be considered “qualified” because it was suggested or put in place by the employer. The tip also has to be reported on tax statements, such as a W-2 or 1099 form. The received tips need to be from a job that regularly gets tips – such as a bartender, barber, or server. Certain high-income trades, such as law and health care, are generally excluded. However, like everything – there is a catch.
The deduction gets phased out or eliminated when the taxpayer’s income is too high; this occurs if the Modified Adjusted Gross Income for the annual tax return is above $150,000 for single filers, or $300,000 if the taxpayer is Married Couples filing Jointly. If you itemize or take the standard deduction, this above-the-line deduction is eligible for all; and like everything – it is subject to Social Security and FICA (Medicare) taxes.
“No Tax on Overtime”
The Qualified Overtime Compensation Deduction is a way for some groups of workers to deduct a portion of their overtime pay from their federal taxable income for the 2025 through 2028 tax years. Single taxpayers may deduct up to $12,500, and couples who file Married Filing Jointly may deduct up to $25,000 per annual tax return.
Unfortunately, not all pay is eligible for the deduction; only the premium pay of the overtime pay (for example, the half portion of receiving time-and-a-half for working overtime) required by the Fair Labor Standards Act (FLSA) is eligible for the deduction. The overtime also has to be not mandated by state law or paid due to a company policy, contract, or bargaining agreement. It also needs to be reported on a Form W-2.
Like the “No Tax on Tips” provision, this also phases out after a certain income. Single taxpayers may see this phase out with income greater than $150,000 as couples who Married Filing Jointly will see this phase out with an income more than $300,000. If you itemize or take the standard deduction, this above-the-line deduction is eligible for all; and like everything – it is subject to Social Security and FICA (Medicare) taxes.
The Bottom Line
The comprehensive tax adjustments introduced under the OBBBA are designed to provide targeted economic stimulus and relief primarily for the millions of American taxpayers who depend on hourly wages, especially those in the service sector who earn substantial tip income or who regularly work overtime. While these new rules deliver a potentially significant reduction in federal income tax liability—as they constitute an “above-the-line” deduction—taxpayers must navigate a complex, two-tiered system where state tax conformity remains highly uncertain. This decoupling means that states may continue to fully tax the tips and overtime amounts that are federally deducted, creating a necessary dual calculation process for filers and adding significant complexity to state tax returns. Furthermore, the effectiveness of the OBBBA provisions depends fundamentally on a massive administrative shift: employers are now legally mandated to separate and correctly report “qualified tips” and “qualified overtime compensation” on employee W-2 forms, an obligation so novel that the Internal Revenue Service (IRS) has proactively offered penalty relief for the 2025 transition year to accommodate inevitable implementation errors. Therefore, the charge is on the diligent taxpayer to ensure their employer has properly documented these wages, as the deduction itself is claimed only after reporting the total gross income, with the benefit realized as a reduction on the final tax return.
