Both the No Tax on Tips and No Tax on Overtime provisions apply beginning January 1, 2025, and remain in effect through 2028.
1. NonTaxable Tips Deduction
The BBB allows eligible workers to deduct qualified tips from their federal taxable income. This does not mean tips are excluded from wages on paychecks; instead, workers claim a deduction on their tax return.
Key points:
- Applies to workers in a “specified service trade or business”, such as restaurants, hospitality, salons, and similar industries.
- Workers may deduct qualified tips they received during the tax year.
- Because W2s will not separately report tips for 2025, the IRS allows workers to use reasonable methods to calculate their deductible amount.
- Employers must still follow normal tipreporting rules for payroll and FICA.
2. NonTaxable Overtime Deduction
The BBB also creates a deduction for qualified overtime compensation.
Key points:
- Workers may deduct overtime pay earned at the federal overtime rate (typically timeandahalf).
- Like tips, overtime will not be separately reported on 2025 W2s, so workers must calculate their own deductible amount using reasonable methods.
- Applies to both employees and certain contractors receiving overtimeequivalent compensation.
Because reporting systems lag behind the law, the IRS guidance allows:
- Reasonable estimation methods for tips and overtime
- Use of personal records, employer statements, pointofsale data, or other documentation
- Transition relief for workers in industries where tips are irregular or pooled
The IRS will update forms and instructions in future years to simplify reporting.
Payroll teams should also be aware that employees may ask for yearend statements or data to support their deduction calculations.