Tax Breaks Ahead: Tip and Overtime Tax Relief for 2025

Thanks to new federal legislation, employees may soon qualify for significant tax breaks on tip and overtime pay. Beginning with wages earned in 2025, individuals in eligible roles will be able to deduct portions of their reported tip income and overtime compensation when filing their federal tax returns. These deductions apply to the 2025–2028 tax years and are designed to offer targeted relief to hourly and tip-based workers.

For tip income, employees in occupations that are customarily tipped—such as those in hospitality, food service, and personal care—can deduct up to $25,000 per year in qualifying tips. These tips must be reported on a W-2, 1099, or Form 4137. To qualify, the individual’s occupation must appear on a list the IRS will publish by October 2, 2025. The deduction phases out for individuals with a modified adjusted gross income above $150,000, or $300,000 for joint filers. Self-employed workers may also qualify with some limitations. The deduction is available to both itemizing and non-itemizing taxpayers, but not to individuals or employers in “Specified Service Trades or Businesses” such as law, consulting, or healthcare.

For overtime, employees may deduct the portion of overtime compensation that exceeds their regular hourly rate—commonly referred to as the “extra half” of time-and-a-half pay. The annual deduction limit is $12,500 for individuals and $25,000 for joint filers. Like the tip deduction, it is subject to income thresholds and eligibility requirements.

Employers play a key role in enabling these deductions. You will be required to report both qualified tips and total qualified overtime compensation to the IRS or SSA and provide detailed statements to employees to support their tax filings. The IRS has committed to offering transition relief for tax year 2025 and will provide further guidance on occupation eligibility and reporting instructions.

These changes are not yet active, but employers should begin planning now. Payroll systems, time-tracking practices, and reporting formats may all require updates to ensure compliance and provide accurate records for employees. This is an opportunity to demonstrate support for your workforce while ensuring proper alignment with upcoming tax requirements.

Learn more here or get in touch with your Payroll Specialist directly.