Welcome to the fifth installment in TRP Sumner PLLC’s series of articles exploring key components of the One Big Beautiful Bill (OBBB), enacted in 2025. Our goal is to provide clear, practical insights into the provisions of this comprehensive tax legislation that impact our clients. In this article, we discuss the new temporary above-the-line deductions for tips and overtime pay, including their implications for taxpayers and payroll filings.

Executive Summary:

New Deductions for Tips and Overtime Pay: Who Benefits?

The OBBB introduces two temporary above-the-line deductions, designed to provide targeted tax relief for workers in industries where tips and overtime are common, such as hospitality, healthcare, retail, and construction. These deductions apply for tax years 2025 through 2028 and allow taxpayers to reduce their adjusted gross income (AGI), whether they itemize or take the standard deduction. Eligible taxpayers may deduct up to $25,000 in tips and up to $12,500 in overtime pay ($25,000 for joint filers) per year.

Overview of the New Deductions

Tips Deduction: Taxpayers can deduct up to $25,000 of tip income received in a tax year. This applies to employees who earn tips directly (servers, bartenders, drivers) or through tip-sharing arrangements.

Overtime Pay Deduction: Taxpayers can deduct up to $12,500 in overtime pay if filing as single, head of household, or married filing separately, and up to $25,000 if married filing jointly. Overtime refers to wages earned for hours worked beyond a standard workweek (generally 40 hours), as defined by federal or state law.

These deductions are temporary, capped at the amounts above, and not subject to income-based phase-outs. Proper documentation is required.

Who Qualifies?

Tips Deduction: Applies to tips reported to the IRS, typically through Form W-2 (Box 1 or Box 7) or self-reported on tax returns for self-employed individuals and gig workers. Tips must be earned in the course of a trade or business, such as food service, salons, or transportation.

Overtime Pay Deduction: Applies to overtime wages reported on Form W-2 (Box 1) and designated as overtime pay by the employer. Documentation such as pay stubs or employer statements may be necessary.

Both deductions are claimed on the taxpayer’s return as adjustments to income, reducing AGI before standard or itemized deductions are applied.

Benefits for Taxpayers

Reduced Taxable Income: A single filer earning $30,000 in tips could deduct $25,000, reducing AGI significantly and lowering federal tax liability (e.g., saving about $5,500 in a 22% bracket).

Broad Accessibility: As above-the-line deductions, they benefit all eligible taxpayers, whether or not they itemize.

Targeted Relief: Workers in industries where tips and overtime represent substantial income gain meaningful support.

Temporary Advantage: Benefits are available through 2028, giving workers a four-year window to maximize tax savings.

Impact on Payroll Filings

The new deductions also affect employer payroll processes:

Tip Reporting: Employers must continue accurate reporting of tips. Employees are required to report tips (e.g., via Form 4070), which employers include on Form W-2. While OBBB does not change 2025 W-2 reporting rules, proper substantiation is critical.

Overtime Pay Identification: Employers should clearly identify overtime pay in payroll records. While it appears in W-2 Box 1, additional statements or pay stubs may help employees substantiate the deduction since the 2025 W-2 form has not changed. 

Payroll Systems: Employers may need to update payroll systems to track overtime separately and confirm compliance. We can expect changes in the 2026 W-2 form to accommodate overtime and tip reporting. 

Employee Education: Employers should inform employees about documentation requirements and potential tax benefits.

Self-employed individuals earning tips (such as gig workers) should keep detailed records and report tip income on Schedule C.

Key Considerations

Documentation: Employees must retain pay stubs, tip logs, or employer statements to support deductions.

Temporary Nature: Both deductions expire after 2028. Taxpayers should plan ahead for changes in 2029.

No Income Limits: These deductions apply regardless of income level.

State Rules: Some states may not conform to the federal deductions; check state-level requirements.

Planning Opportunities

Keep Accurate Records: Employees should carefully track qualifying tip and overtime income.

Review Withholding: Adjust Form W-4 to reflect lower taxable income, improving cash flow.

Consult a Tax Professional: Ensure deductions are properly claimed and coordinated with other tax credits.

Employer Compliance: Businesses should review payroll procedures to ensure proper tracking and reporting.

At TRP Sumner PLLC, we’re here to assist both employees and employers in navigating these new deductions. Whether you’re an individual seeking to maximize your tax savings or a business ensuring compliance with payroll reporting, contact our team for personalized guidance. Stay tuned for the next article in our OBBB series, where we’ll explore another key component of this legislation.