No Taxes on Overtime and Tips: What Businesses Should Know

Update (4/30/26): The IRS and the Treasury department have finalized the list of occupations eligible for no tax on tips and clarified language of what are qualified tips. Read below for more details.

Update (11/12/25): Additional guidance by the IRS designates Tax Year 2025 as a transition year, providing employers with penalty relief on reporting requirements regarding cash tips and overtime compensation. See the respective section below for more details.

Original article

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. Since that time, employees who receive this additional compensation and employers who need to understand their requirements have been asking questions and seeking guidance to help meet their compliance requirements.

The IRS began providing guidance in September with a draft list of the types of jobs that are covered by this provision in the law. On Nov. 4, the IRS announced that the 2025 Tax Year will be a transition year, offering employers relief from penalty on the reporting requirements related to no taxes on tips and overtime compensation.

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

Is There a Specific Form to File for the Deduction?

The IRS released a draft Form Schedule 1-A on Sept. 30 that may be used by individuals who want to claim one of the several deductions when filing taxes in 2025. The form is not official yet and could be changed by legislation. One of the issues causing confusion was the box listed on Schedule 1-A where qualified overtime compensation would be listed on a W-2 is the same box as where total taxable wages and tips are listed, and not just the qualified overtime compensation amount.

In November, the IRS acknowledged that the information required to report might not be available to employers since the law didn’t take effect until July of 2025. So, employers are free from penalty for failing to provide information on the total amount of qualified OT compensation and an account of the total amount of reasonably designated cash tips.

The agency is encouraging employers to provide occupation codes to employees and as much detail as they can on cash tips and overtime pay that will assist employees in claiming other deductions.

The Schedule 1-A eventually could be used to claim a deduction on the following:

• Qualified tip income
• Qualified overtime pay
• Car loan interest
  • Loan must be taken out in 2025 to buy a new car assembled in the United States.
• An enhanced deduction for qualified seniors ages 65 and older
  • There is a phase out that begins for gross incomes of $75,000 (filing single).

These are below-the-line tax deductions, which means an individual will be able to lower their taxable income but not their adjusted gross income with these deductions.

All income thresholds of the federal law remain in place.

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.

<iframe allow="autoplay *; encrypted-media *; fullscreen *; clipboard-write" frameborder="0" height="175" style="width:100%;max-width:660px;overflow:hidden;border-radius:10px;" sandbox="allow-forms allow-popups allow-same-origin allow-scripts allow-storage-access-by-user-activation allow-top-navigation-by-user-activation" src="https://embed.podcasts.apple.com/us/podcast/no-tax-on-tips-what-is-known-and-what-do-we-still-need-to-know/id1507824762?i=1000728371298"></iframe>

What Jobs Qualify for No Tax on Tips?

In mid-April 2026, the Treasury and IRS grouped the occupations into eight categories under a distinct three-digit code, as follows:

• 100s - Beverage and Food Service
• 200s - Entertainment and Events
• 300s - Hospitality and Guest Services
• 400s - Home Services
• 500s - Personal Services
• 600s - Personal Appearance and Wellness
• 700s - Recreation and Instruction
• 800s - Transportation and Delivery

The final regulations list more than 70 occupations, which were expanded to include visual artists and floral designers under Personal Services and added gas pump attendants in the Transportation and Delivery category. Individuals in these jobs customarily received tips (prior to Dec. 31, 2024) and qualify for the deduction.

The agencies also addressed the definition of a qualified tip, which first and foremost must be received by an individual whose job is on the list of occupations that receive tips. Additional requirements include tips being paid in cash or a medium such as check, credit card, debit card, gift card, or by a mobile payment app. Tips must be received voluntarily from customers or, in the case of an employee, through a mandatory or voluntary tip-sharing arrangement (e.g., tip pool). Qualified tips do not include service charges unless the customer can disregard or modify the charge. Any automatic service charge (e.g., 18% for large parties) distributed to wait staff and kitchen staff that is added without an option by the customer to disregard or modify the amount is not considered a qualified tip.

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

The IRS has 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. The deduction is available only for qualified tips included on Form W-2, Form 1099-NEC, Form 1099-MISC, Form 1099-K, or reported by a worker on Form 4137.

Gig workers and self-employed individuals can take the deduction if their occupation is on the List of Occupations that Receive Tips.

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).

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:

• Eligible W-2 employees may claim this benefit.
  • There has been some confusion about whether a 1099 worker is eligible, but a correctly classified independent contractor fails to meet the definition of a covered employee under the Fair Labor Standards Act. Since the law indicates "qualified overtime" under section 7 of the FLSA, a 1099 worker would not be eligible.
  • There is language in the reporting section that indicates 1099 workers, but that has to do with the FLSA and the IRS having different definitions for independent contractor classification.
• 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.