On July 4, 2025, the One Big Beautiful Bill Act (H.R.1) was signed into law. Among its many provisions, the Act introduces significant changes to the federal tax treatment of overtime and tips - changes that will impact payroll, employment taxes, and employee benefits starting in tax year 2025.

Here’s a breakdown of the key updates employers need to understand:

Overtime: New Federal Income Tax Deduction

What’s Changed?
The Act introduces a new federal income tax deduction for “qualified overtime,” available from tax years 2025 through 2028. This deduction is retroactive to January 1, 2025, and will be claimed on employees’ individual federal returns.

Which Taxes Are Affected?
The deduction applies only to federal income taxes. Employers and employees must still pay applicable Medicare and Social Security taxes on overtime earnings.

What Counts as “Qualified Overtime”?
To be deductible, overtime must:

• Be required under Section 7 of the Fair Labor Standards Act (FLSA).

• Include only the premium portion of the overtime pay—typically the additional 0.5x paid above regular wages.

Example: An employee earning $10/hour receives $15/hour for overtime under FLSA rules. Only the $5/hour premium qualifies for the deduction.

What Doesn't Qualify?

• Overtime paid under state laws, collective bargaining agreements, or voluntary employer policies that go beyond FLSA requirements are not eligible.

• Daily overtime (e.g., after 8 hours in a day) is excluded if not mandated by Section 7 of the FLSA.

Is There an Income Limit?
Yes. The deduction begins to phase out once an individual’s modified adjusted gross income (MAGI) exceeds:

• $150,000 for single filers

• $300,000 for married filing jointly

Do You Have to Itemize to Claim It?
No. The deduction is available whether taxpayers take the standard deduction or itemize.

Tips: A New Deduction for Service Industry Employees

What’s Changed?
Employees in tip-based roles can now deduct up to $25,000 of “qualified tips” from their federal income, also retroactive to January 1, 2025. This provision also runs through tax year 2028.

Which Taxes Are Affected?
Like the overtime deduction, this applies only to federal income taxes. Medicare, Social Security, and state income taxes still apply to all tip income.

What Counts as “Qualified Tips”?
Tips must:

• Be cash tips (including those paid by card or via tip-sharing pools)

• Come from an occupation that customarily received tips on or before December 31, 2024

• Be voluntarily paid by the customer (mandatory service charges or gratuities are excluded)

What Occupations Qualify?
The U.S. Department of the Treasury will publish an official list of qualifying tipped occupations within 90 days of the Act’s enactment. Certain professions—such as law, healthcare, finance, consulting, and performing arts—are explicitly excluded.

Is There an Income Limit?
Yes. The phaseout thresholds match the overtime deduction:

• $150,000 MAGI for individuals

• $300,000 MAGI for joint filers

Is Itemization Required?
No. Taxpayers can claim the deduction even if they take the standard deduction.

What Employers Should Do Next

If you have employees earning overtime or tips, it’s important to:

• Inform them of these new tax-saving opportunities

• Keep accurate records of eligible overtime and tip income

• Monitor updates from the IRS and Department of the Treasury on implementation and compliance

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