No Tax on Tips and Overtime (2025

This article explains how the new federal “No Tax on Tips” and “No Tax on Overtime” deductions work and what they mean for you and your employees.

What changed?

For tax years 2025–2028, employees may be able to deduct certain tip and overtime income on their personal federal tax returns.

Up to $25,000 of qualified tip income per filer can be deducted each year (up to $25,000 per filer, 50,000 per married couple for tips plus overtime combined).
Up to $12,500 of qualified overtime compensation per filer can be deducted each year (up to $25,000 for married couples filing jointly).
These are above‑the‑line federal deductions claimed on Form 1040, not changes to how payroll is calculated during the year.
The deductions begin to phase out when an employee’s modified adjusted gross income (AGI) exceeds $150,000 ($300,000 for married filing jointly).

Eddy will continue to calculate and withhold federal income tax, Social Security, and Medicare on full wages (including all tips and overtime). The deduction is applied later when employees file their tax returns.

How the tip deduction works

Starting with the 2025 tax year, eligible workers can deduct up to $25,000 of qualified tip income from their federal taxable income.

Qualified tips:

Are voluntary, customer‑determined amounts (cash, credit card, or pooled tips).
Are earned in “traditionally tipped” occupations identified by the Treasury (for example, servers or hair stylists).
Must still be reported to the employer and included in payroll.

Note that worker paychecks do not change; normal payroll taxes are still calculated on the full wage amount (including tips). When the employee files their federal tax return, they use the qualified tip total to claim the deduction, which can increase their refund. The deduction amount is reduced for higher‑income employees as the AGI phase‑out applies.

How the overtime deduction works

Employees can also deduct up to $12,500 of qualified overtime compensation each year ($25,000 for married couples filing jointly) on their federal tax return.

Qualified overtime:

Is the additional pay for hours worked over 40 in a week at time‑and‑a‑half under federal law.
Must be paid at least 1.5 times the regular hourly rate.

Important: the deduction is based on the overtime premium, not the entire overtime paycheck.

Example:

Regular rate: 10 per hour.
Overtime hours: 10 hours.
Total overtime pay at time‑and‑a‑half: 10 hours × 15 = 150.
Only the 50 overtime premium (10 hours × 5) is treated as qualified overtime compensation for this deduction, not the full 150.

What you will see on W‑2s and 1099s

Beginning with the 2025 tax year, employers will report qualified tip and overtime amounts separately on year‑end forms.

On Form W‑2:

Box 12, Code “TT”: total qualified tips for the year.
Box 12, Code “OT”: total qualified overtime compensation for the year.
Boxes 1, 3, and 5 will still show full taxable wages, including tips and overtime, for income tax and FICA purposes.

For contractors:

Qualified tips will appear on Form 1099‑NEC, Box 7 with code “TT.”
Qualified overtime will appear on Form 1099‑MISC, Box 3 with code “OT.”

These codes help employees and tax preparers identify the amounts that may be deductible on the federal return.

What this means for Eddy customers

Here’s what to expect as an Eddy admin or payroll manager:

Payroll calculations: Eddy will continue to calculate gross pay and withhold taxes on full wages (including all tips and overtime).
Tracking: Eddy can track tip income and overtime hours according to your setup, making it easier to identify qualified amounts.
Reporting: W‑2 and applicable 1099 forms will include the new codes “TT” and “OT” to show qualified tips and overtime where required.

Employees will use these reported amounts when they or their tax preparer file federal tax returns for 2025–2028.

FAQs

Does this change employee paychecks during the year?
No. Regular paychecks will not change. Federal income tax, Social Security, and Medicare are still withheld based on full wages, including tips and overtime. The benefit appears as a larger refund (or lower tax due) when the employee files their federal return.

Do these deductions lower Social Security or Medicare (FICA) taxes?
No. The new deductions only reduce federal taxable income on the tax return. Social Security and Medicare are still calculated on the full wage amount, including all tips and overtime.

Do these deductions apply to state income tax?
Not by default. These provisions apply to federal income tax only, unless a state independently adopts similar rules.

How long are these deductions available?
The “No Tax on Tips” and “No Tax on Overtime” deductions apply to tax years 2025–2028. They will expire after the 2028 tax year unless Congress extends them.

For questions about how these rules apply to a specific employee’s tax situation, direct them to their tax advisor or the IRS. This article is for informational purposes and does not provide legal or tax advice.