The Internal Revenue Service has released new guidance clarifying significant tax deductions for millions of American workers who earn tips and overtime pay. These changes, set to take effect for the 2025 tax year, could provide substantial financial relief for individuals in service and hourly-paid industries across the country.
The new rules stem from provisions within the One Big Beautiful Bill Act and are expected to impact an estimated 6 million workers who report tipped wages annually. The guidance from the IRS and the Treasury Department outlines specific limits and eligibility criteria for these new tax benefits.
Key Takeaways
- New IRS guidance allows deductions for tips and overtime pay starting in tax year 2025.
- Workers can deduct up to $25,000 in tips and up to $12,500 in overtime premiums annually.
- Deductions are subject to income phase-outs, beginning at a modified AGI of $150,000 for single filers.
- The changes are temporary, available for tax years 2025 through 2028.
- Employers are encouraged to provide necessary documentation to help workers claim these new benefits.
New Deduction for Tipped Employees
Workers in professions where tips are a significant part of compensation will be able to claim a new deduction. This includes restaurant servers, bartenders, delivery drivers, and other service providers who customarily receive gratuities.
Under the new rules, eligible taxpayers can deduct up to $25,000 per year in qualified tips. This deduction is designed to lower the taxable income for a large segment of the American workforce, particularly in the hospitality sector.
Who Is Affected?
The IRS estimates that approximately 6 million workers report tipped wages each year. This new deduction has the potential to directly impact the household finances of these individuals, offering a significant reduction in their annual tax liability.
Income Limitations Apply
It is important to note that this tax benefit is not available to all earners. The deduction for tips begins to phase out for individuals with a modified adjusted gross income (AGI) exceeding $150,000. For married couples filing jointly, the phase-out threshold is $300,000.
This income cap ensures the tax relief is targeted toward low- and middle-income workers who rely most heavily on tipped wages. Taxpayers with incomes above these levels will see their potential deduction reduced or eliminated entirely.
Understanding the Overtime Pay Deduction
Alongside the changes for tipped workers, the IRS has introduced a separate deduction for overtime pay. This benefit is specifically for the premium portion of overtime compensation, as defined by the Fair Labor Standards Act (FLSA).
The FLSA generally requires employers to pay non-exempt employees at a rate of one-and-a-half times their regular rate for hours worked beyond 40 in a workweek. The new deduction applies to the extra "half-time" premium pay, not the total overtime earnings.
How the Overtime Deduction Works
For example, if an employee earns $5,000 in overtime premium pay during the year, that specific amount may be deductible. If their payroll statement shows $15,000 in total overtime compensation, they must identify the portion that qualifies as the FLSA-required premium to claim the deduction.
The maximum annual deduction for overtime premiums is set at $12,500 for individual filers. This limit is doubled to $25,000 for married couples who file a joint tax return. Similar to the tip deduction, this benefit is also subject to the same AGI phase-out limits of $150,000 for single filers and $300,000 for joint filers.
What Workers and Employers Need to Know
The new deductions are scheduled to be available for a limited time, covering the tax years from 2025 through 2028. This means taxpayers will first see these changes when they file their 2025 tax returns in early 2026.
The IRS has stated it is currently working to update tax forms and instructions to accommodate these new deductions.
“The IRS is in the process of updating income tax forms and instructions for taxpayers to use this filing season that will assist them in claiming these deductions,” the agency announced. “The IRS will continue to update taxpayers about tax benefits from the One, Big, Beautiful Bill on IRS.gov.”
The Role of Documentation
Proper documentation will be critical for workers who wish to claim these benefits. For tipped employees, amounts reported on a Form W-2 or tracked on Form 4137 (Social Security and Medicare Tax on Unreported Tip Income) will be essential.
For overtime, clear payroll statements that distinguish between regular pay and the FLSA overtime premium will be necessary. While employers will not face penalties for failing to provide separate reporting for the 2025 tax year, the IRS is encouraging them to assist their employees by providing clear and detailed earnings statements.
Preparing for Tax Season 2026
As the 2025 tax year approaches, workers who may be eligible for these deductions should begin preparing now. Key steps include:
- Accurate Record-Keeping: Maintain detailed records of all tips received, whether cash or electronic.
- Review Pay Stubs: Understand how your employer reports overtime pay and ask for clarification if the premium portion is not clearly identified.
- Consult a Professional: As tax laws change, consulting with a tax professional can help ensure you correctly claim all eligible deductions and avoid potential issues with the IRS.
These new tax provisions represent a significant policy shift aimed at providing financial relief to millions of hourly and service-industry workers. By understanding the rules and preparing in advance, eligible taxpayers can ensure they take full advantage of these temporary benefits when they become available.
