No Taxes on Overtime and Tips: What Businesses Should Know

The president’s campaign promise of no taxes on tips and no taxes on overtime pay was fulfilled with the signing of the tax law, H.R. 1, in July 2025. With only four months left in the year, employees who receive this additional compensation and employers who need to understand their requirements are starting to ask how this will be put into action.

The IRS began providing guidance in September on the types of jobs that are covered by this provision in the law, and the law also offers details. However, additional guidance on what taxpayers will do in 2025 remains unclear.

This article helps level set what is known to offer some clarity.

Will Employee Checks Be Bigger With No Taxes on Tips and OT?

Initially, in general, there will not be more money in an employee’s paycheck each pay period for the new deduction, given there is no specific adjustment to the federal W-4 in 2025 to accommodate for these new deductions. Individuals who receive tips and overtime pay will have to pay taxes on that money. There are FICA taxes (an employee’s share of Social Security and Medicare), plus taxes based on your income tax bracket, as well as state taxes in applicable states.

In 2026, the draft W-4 makes changes to reflect the new law, including factoring in these new deductions on the deduction worksheet. Once the 2026 W-4 is finalized, if an employee fills out a new W-4 to account for these deductions, their federal income tax withholding may be reduced translating into a potential increase in each paycheck.

Are No Taxes on Tips and OT a Tax Deduction or Tax Credit?

The no taxes on tips and overtime pay are tax deductions. These are applied to one’s gross income at the time taxes are filed (prior to April 15 each year), which lowers the adjusted gross income and ultimately the tax owed in accordance with an individual’s tax bracket.

If, for example, an employee in the 24% tax bracket gets a $5,000 deduction, then taxes would be reduced by $1,200 (assuming $5,000 is all taxed at the 24% marginal rate).

So, an employee might see a refund after filing taxes, but it doesn’t necessarily equate to paying no taxes on the money from tips and overtime.

Are Their Limits on How Much Tips and OT Can be Claimed?

Yes, the law places a cap on how much of an employee’s tips and qualified overtime pay can be used toward the deduction. From 2025 to 2028, individuals who receive qualified tips may deduct up to $25,000 annually from their federal taxable income.

There also is a phase-out in place for individuals making an adjusted gross income of $150,000 (for married couples filing jointly, it’s $300,000), which is a reduction of $100 for every $1,000 over the cap.

The annual deduction limit for individuals who have received overtime pay is $12,500 (and $25,000 for joint filers). There are also phase-out limits for adjusted gross incomes (individuals $150,000; married couples filing jointly $300,000), which will lower the benefit.

What Jobs Qualify for No Tax on Tips?

On Sept. 3, 2025, the U.S. Treasury Department released a preliminary list of almost 70 occupations that customarily received tips (prior to Dec. 31, 2024) and may qualify for the deduction. Official guidance, when released, might change some of this, but this is what is known as of now. The preliminary list contains obvious jobs that might qualify:

• Bartenders, wait staff, and many roles related to food and beverage prep
• Gambling-related roles (e.g., dealers)
• Entertainment (e.g., DJs, ushers)
• Hospitality/guest services (e.g., bellhops, concierges)
• Others, including influencers, digital content creators, and Uber drivers

However, some questions have arisen, including verbiage in the law that states “tips must be paid voluntarily” and “are determined by payor.” Guidance is needed on that because questions exist about instances where a gratuity automatically is added to a bill, meaning it wasn’t voluntary nor did the payor determine the amount.

How Will Tips and Overtime Be Accounted for on Tax Forms?

The IRS already announced that it will not make changes to the existing Form W-2, Forms 1099, and Form 941 nor to the withholding tables for Tax Year 2025. Employers are instructed to continue using current reporting and withholding procedures for qualified tips and overtime compensation. The agency has released a Form W-2 draft, but it is for Tax Year 2026.

Also keep in mind that in 2026 the W-4 will accommodate for these deductions so there may be more per pay period if individuals adjust their withholding on their W-4.

Employers still need to know where to report tips and indicate the employee’s occupation, as well as where to show the amount of qualified overtime paid to an employee during the year.

For employers with tipped employees who use the FICA tip credit, the new law changed the Internal Revenue Code (IRC) as to what tips are eligible for the credit, expanding beyond those received for providing, delivering and serving food to include those tips received in the beauty services (e.g., barbers, hair care, nail care).

There also are questions about how to handle tipped employees who also receive overtime, so businesses avoid double-dipping with their calculations.

What are the Eligibility Rules for Claiming No Tax on Overtime?

There are income threshold eligibility rules (as stated above) to be able to claim no tax on overtime pay. Additionally, these rules apply:

• An individual must be a W-2 employee; independent contractors and gig workers cannot claim this benefit.
• An individual cannot claim the benefit with a tax filing status of Married Filing Separately.
• Recipients of overtime pay must have a valid social security number.
• Overtime worked by employee must be required under the Fair Labor Standards Act.
• Only the excess portion (the half portion of time and a half) qualifies.

With a cap of $12,500 annually ($25,00 if married filing jointly), all overtime compensation above that threshold is subject to federal taxes.

Guidance is still required on how qualified overtime compensation will be defined, adjustments needed to Form W-4, and what will transition relief be for taxpayers claiming the deduction in Tax Year 2025.

How Could State Tax Filing Be Impacted?

Employers and employees must give attention to state laws when reporting and filing taxes, respectively, under the no taxes on tips and overtime provision in the new federal law.

For example, in 2025, California employees must report their full tip and overtime earnings as taxable income because there is currently no state-level deduction.

Employers must ensure they only report the employee’s eligible overtime, and not OT owed under state law that requires payment of overtime after working more than eight hours.

California’s overtime laws are more expansive than the federal FLSA, and only overtime worked required under FLSA qualifies for the eventual deduction under the tax law. Therefore, the portion of a California worker's overtime pay earned between 8 and 12 hours in a day might not qualify for the new federal deduction if those hours are not required overtime pay under the FLSA.

Employers and employees also need to be ready to respond if a state sets up a different treatment concerning state income taxes for overtime and tips earnings. Take, for example, Colorado, that passed a law in May 2025 that decouples it from the federal tax law. The state law requires the inclusion of all overtime pay, including such pay that might qualify for the federal deduction, in an individual’s taxable income.

Keep in mind that states could choose to follow the changes to federal law or decouple from these provisions if they currently follow the IRC.

Paychex Helps With Tax Compliance

Paychex will continue monitoring the process. The implications of this law might impact businesses of all sizes, affecting their processes involving payroll, taxes, and compliance requirements. Working with a trusted leader such as Paychex can help businesses make the required necessary adjustments to their workplace processes.