Millions of US workers might see changes to their overtime salaries due to potential federal tax deductions in the upcoming tax year of 2025.
However, which workers will actually benefit from this new deduction is still a point the government needs to clarify after President Trump’s recent spending and policy package gains approval from Congress.
Following the bill Trump signed on July 4th, the US Treasury is required to release a list of eligible occupations for tax-free tips by October 2nd. The department is also likely to provide instructions on reporting overtime payments and the necessary documentation.
The deduction isn’t permanent; it’s set to expire after the 2028 tax year.
Currently, overtime pay is not specifically itemized on employee W-2 forms, although employers typically track it and include it in pay stubs, explains Miguel Burgos, a CPA at TurboTax. He also noted that employers will need to continue withholding taxes until further guidance is given. It’s worth mentioning that this bill does not extend to state and local taxes or federal payroll taxes, including Social Security and Medicare.
Here’s what we know about tax-free tips and overtime:
Who is likely to qualify for tax-free tips?
The bill suggests that workers who have received regular tips as of December 2024 will be eligible. The National Restaurant Association highlights that the restaurant sector has around 2.1 million servers and bartenders. It’s anticipated that other professions, such as barbers, hairdressers, nail technicians, and delivery drivers, will also be included. To qualify, workers need to provide a Social Security number on their tax returns, and if they’re married and filing jointly, their spouse’s number is also required.
How much can qualifying workers deduct?
Workers earning less than $150,000 (or $300,000 if married) can deduct tips up to $25,000, although the deduction reduces by $100 for every $1,000 over the $150,000 threshold.
Who stands to benefit the most from not having to pay federal taxes on tips?
The Nonpartisan Tax Policy Centre indicates that about 40% of the workers will see little to no change in their income tax payments, while the remaining 60% could enjoy average tax cuts of around $1,800 annually.
What types of tips are included?
The deductibles cover both cash and credit card tips, including pooled tips among restaurant staff. However, servers might be less inclined to participate in tip pooling since it is typically deductible. It’s important to note that the bill specifies that the eligible tips must be paid voluntarily, excluding service charges like automatic gratuities for large parties.
Who is eligible for tax-free overtime?
According to Yale’s Budget Institute, about 8% of hourly workers and 4% of salaried employees regularly receive overtime compensation under the Fair Labor Standards Act. Various roles, including clergy, educators, and executives, are generally exempt from federal overtime regulations.
How much can workers deduct for overtime from federal taxes?
Qualifying workers can deduct up to $12,500 in overtime (or $25,000 for joint filings). Similar to tip deductions, earnings exceeding $150,000 will result in a reduction of the deductible amount. A Social Security number must also be included in the submission.
What is the potential tax reduction from the overtime deduction, and how feasible is it?
Average workers can expect tax cuts ranging from $1,400 to $1,750 annually, as per estimates from the White House Council of Economic Advisors.
It’s projected that tax-free tips will decrease federal revenue by $31 billion between 2026 and 2029, while tax-free overtime deductions will reduce revenue by $90 billion over the same timeframe, according to analysis by the Nonpartisan Taxation Commission.
