On July 4, 2025 President Trump signed The One Big Beautiful Bill act (OBBB) into law. This latest round of tax legislation brings major changes that will impact individual taxpayers and business over the next few years. Employees and employers might particularly be interested in the changes coming to overtime taxation and tax-free tips.
Abacus Payroll’s affiliate Alloy Silverstein Accountants and Advisors will continue to publish informative updates regarding the One Big Beautiful Bill Act in their Tax Reform Resource Center.
Tips and Taxes for 2026
This new provision is designed to provide relief for service industry workers who rely on tips as a key part of their income. Here’s what you need to know about how it works and who qualifies.
What is a Qualified Tip?
A qualified tip is any cash tip received in an occupation where tipping is customary and regular. Think of jobs like waitstaff, bartenders, hairdressers, baristas, and other service industry roles where receiving tips is an expected part of the job.
For example, tipping your hairstylist would count, but tipping your auto mechanic, where tipping is not a standard practice, would not qualify. To ensure consistency, the Treasury Secretary has until October 2, 2025, to publish an official list of occupations that customarily receive tips.
Key Rules for Tax-Free Tips:
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The tip must be voluntary. It cannot be compulsory, negotiated, or built into the service fee.
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The tip amount must be determined solely by the customer.
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To claim the deduction, tips must be reported on official income statements such as a W-2 or 1099.
How Much Can You Deduct?
You will be able to deduct up to $25,000 from your taxable income for qualifying tips, and you don’t need to itemize your deductions to take advantage of this benefit. However, there are some important income and filing requirements to keep in mind:
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Filing Status:
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You must file as Single or Married Filing Jointly to claim the deduction.
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Married Filing Separately filers are not eligible.
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Income Limits:
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Full deduction available if your Modified Adjusted Gross Income (MAGI) is $150,000 or less (or $300,000 for joint filers).
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The deduction gradually phases out and disappears completely once MAGI reaches $400,000 for individuals or $550,000 for joint filers.
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Planning Ahead
Since the deduction only applies to tips that are officially reported, workers and employers alike should ensure accurate recordkeeping. Properly reporting tips on your W-2 or 1099 will be essential for claiming this new benefit.
VIDEO – No Tax on Tips: What You Need to Know About the New Tax-Free Tip Rule
New Overtime Tax Break
One of the standout features of the 2025 tax legislation is a new provision that makes qualified overtime pay tax-free for tax years 2025 through 2028. This change is expected to benefit millions of workers across the country who regularly put in extra hours. However, as with any tax break, there are important rules to follow to ensure compliance and avoid costly mistakes.
How Does the New Overtime Tax Break Work?
Under this new provision, eligible workers will be able to deduct up to $12,500 of overtime pay from their taxable income each year. For married couples filing jointly, the deduction increases to $25,000. This tax break applies whether or not you itemize deductions on your tax return.
To qualify for this deduction:
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The overtime must be paid in accordance with the Federal Labor Standards Act (FLSA) of 1938, which requires that covered, nonexempt employees receive “time and a half” pay for hours worked beyond 40 in a single workweek.
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The deduction is available only to workers who actually earn legitimate overtime. It is not an opportunity for business owners, executives, or professionals (such as doctors, lawyers, or CPAs) to reclassify their salaries as hourly wages in order to claim overtime. Many white-collar positions are exempt from overtime rules based on their job duties or pay level.
Positions generally not eligible for this tax-free overtime include:
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Executive, administrative, and professional employees
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Computer professionals
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Outside sales employees
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Certain agricultural workers
Income Limits and Phase-Out Rules
To benefit from the full deduction:
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Your Modified Adjusted Gross Income (MAGI) must be $150,000 or less for single filers or $300,000 or less for married couples filing jointly.
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The deduction phases out gradually for higher incomes and disappears entirely when MAGI reaches $275,000 for individuals or $550,000 for couples.
It’s also important to note that married couples must file jointly to claim the deduction. Those filing as Married Filing Separately will not qualify.
Changes Coming to the W-2 Form
Since current W-2 Forms do not separately report overtime pay, changes will be necessary to allow both taxpayers and the IRS to properly track these amounts. For the 2025 tax year, which is already underway, the IRS will permit employers to use any reasonable method specified by the Treasury Secretary to approximate and account for qualifying overtime.
Looking ahead to 2026 and beyond, the Treasury Department is required to update payroll withholding procedures to ensure that the overtime deduction is reflected in employees’ income tax withholdings.
What Should You Do Next?
If you earn overtime or manage a workforce where overtime is common, it’s a good idea to start planning now:
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Employees: Keep clear records of your overtime hours and pay.
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Employers: Work with your payroll provider to ensure accurate tracking and compliance.
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High-income earners: Review your income levels to understand whether you’ll qualify for the deduction.