What Does “No Tax on Tips” Mean for Employers?
President Trump signed into law H.R. 1, better known as the One Big Beautiful Bill Act, on July 4. The legislation includes provisions that expand tax deductions on tips and overtime pay, including a broader employer tip credit. Employers may need to update reporting and payroll processes to comply with the new law. Here’s what you should know.
“No Tax on Tips”
Section 70201 details the “no tax on tips” provision of the act. Under this provision, eligible filers can deduct up to $25,000 in tips from their federal income tax, although these tips remain subject to payroll tax. This is an above-the-line, for-AGI (adjusted gross income) deduction, available to all eligible filers (including non-itemizers) starting in 2025. So, who qualifies for this deduction, and what qualifies as a tip?
To qualify, tips must be included on statements furnished to the filer pursuant to Internal Revenue Code sections 6041(d)(3), 6041A(e)(3), 6050W(f)(2), or 6051(a)(18), or reported by the taxpayer on Form 4137. In other words, to claim the deduction, tips must first be claimed and reported.
Qualifying tips up to $25,000 can be deducted annually through Dec. 31, 2028. The deduction includes a phaseout beginning at $150,000 modified AGI for single filers and $300,000 modified AGI for married individuals filing jointly. The deduction is reduced by $100 for every $1,000 over $150,000 for single filers and $300,000 for married filers.
The tax return must include the Social Security number of the individual claiming the deduction. If the individual claiming the deduction is married, the return must be joint and include both parties’ Social Security numbers.
“Qualified tips” are defined as “cash tips received by an individual in an occupation which customarily and regularly received tips on or before December 31, 2024, as provided by the Secretary.” The treasury secretary is charged with publishing a list of such occupations within 90 days of enactment.
The act clarifies that “cash tips” include tips received from customers that are paid in cash or charged, along with tips received under a tip-sharing arrangement. The act does not appear to alter sections 29 CFR 531.53 (“Payments which constitute tips”) and 29 CFR 531.55 (“Examples of amounts not received as tips”) of the Code of Federal Regulations. The act includes language similar to 29 CFR 531.55 – to qualify as a tip, the amount must be paid voluntarily without consequence for non-payment, must not be the subject of negotiation, and must be determined by the payor. Compulsory service charges, like mandatory gratuities for large parties, do not qualify as tips for this deduction.
The act also extends the tip credit for employers under Section 45B of the Internal Revenue Code. Previously, 45(B)(2) was limited to food and beverage serving and delivery. The act amends 45(B)(2) to include barbering, nail care, esthetics and body/spa treatments. Business owners and employers in these sectors should consult with tax professionals regarding this change.
“No Tax on Overtime”
The act’s overtime deduction provisions are similar. The overtime deduction is effective in 2025 and is available annually through Dec. 31, 2028. It is an above-the-line deduction available to all eligible filers (including non-itemizers). Social Security numbers are required on filings claiming this deduction and, if the filer is married, the return must be joint and include both parties’ Social Security numbers. The deduction is for federal income tax only. Overtime wages remain subject to payroll taxes. The deduction reduces by $100 for every $1,000 over $150,000 in modified AGI for single filers and $300,000 for joint filers.
One key difference between the provisions is the face amount of the deduction. For overtime wages, the maximum deduction is $12,500 for single filers, increasing to $25,000 for those who are married filing jointly.
“Qualified overtime compensation” is defined by the act as “overtime compensation paid to an individual required under Section 7 of the Fair Labor Standards Act of 1938 that is in excess of the regular rate (as used in such section) at which such individual is employed.”
As with the no tax on tips provision, employers should consult with tax professionals to determine whether changes or adjustments are warranted.
While both provisions are set to expire at the end of 2028, tax deduction policies for tips and overtime have received broad bipartisan support. It’s possible these provisions, perhaps with modifications, will remain on the books well after 2028.
Contact Jonathan Maples or any member of the Phelps labor and employment or tax teams if you have questions or need advice or guidance.
