In a significant move that could positively impact millions of workers, the Internal Revenue Service (IRS) and the U.S. Department of the Treasury have unveiled new guidelines regarding the taxation of tips and overtime compensation. This announcement comes as part of the recently enacted One, Big, Beautiful Bill Act (OBBBA), which allows individuals receiving “qualified tips” or “qualified overtime compensation” to claim federal income-tax deductions for the tax years 2025 through 2028.
The details surrounding these new deductions are essential for workers to understand as they navigate the upcoming 2025-2026 tax season. Under the new provisions, employees earning tips can deduct up to $25,000 of qualified tips annually. However, this benefit begins to phase out for individuals whose modified adjusted gross incomes exceed $150,000 per year, or $300,000 for those filing jointly. Likewise, overtime compensation under the Fair Labor Standards Act is also addressed. Employees who receive overtime pay can deduct the portion exceeding their regular pay rate, with potential deductions reaching up to $12,500 for individuals and $25,000 for joint filers, also subject to the aforementioned income limits.
Importantly, these deductions are available to all workers, regardless of whether they choose to itemize or take the standard deduction, broadening the scope of potential tax relief.
However, as the 2025 law is set to take effect, tax-reporting systems have yet to adapt to incorporate these changes. Consequently, workers will not be able to rely solely on standard tax forms to claim these new deductions. Instead, they will need to maintain their own records—such as pay stubs, tip logs, 1099-K or 1099-NEC statements from gig apps, and detailed accounts of hours worked and extra pay—to support their deduction claims.
In an additional measure to ease the transition, the IRS has introduced a one-year transition period for 2025. During this period, employers and workers will not face penalties for failing to separately report tips or overtime on pay statements, even though the OBBBA requires such reporting in the future. Thus, 2025 will be considered a “transition year,” placing the onus of documentation largely on the workers.
To prepare for the upcoming changes, workers reliant on tips, overtime, or gig income should start organizing their documentation immediately. Recommended items include pay stubs evidencing overtime hours or bonuses, detailed tip logs with the dates, amounts, and methods of payment, earnings statements from third-party employment platforms, and any employer documentation related to overtime pay.
With the prospect of reduced federal tax burdens for those who qualify, individuals expecting to receive tips or overtime in 2025 should be proactive in gathering the necessary documentation to take full advantage of these deductions.
