Tipped and Overtime Income Deductions in the One Big Beautiful Bill and Beyond

Introduction

H.R. 1 - One Big Beautiful Bill Act (OBBBA), the reconciliation bill passed by Congress, enacted a range of individual and business tax reforms, including new deductions for tipped income and overtime pay. While these provisions will offer relief to many workers, they will also require clear guidance from the Treasury Department and IRS to prevent abuse and confusion over eligibility. Tax professionals have already raised concerns about gray areas—such as the treatment of mandatory service charges—that could complicate compliance for employers and workers alike.

With both provisions set to expire at the end of 2028, Congress should monitor how the pilot deductions are implemented and potentially consider a simpler and more fiscally responsible alternative combined deduction which would better serve workers and taxpayers.

Taxation of Tips and Overtime Before OBBBA

Before OBBBA, both tips and overtime pay were fully taxable like standard wages. Tips can include cash, credit card payments, pooled tips, and even non-cash items. The IRS requires tipped workers to track their daily tips, report them monthly to their employers, and include them in their tax returns. Yet, in practice, compliance is inconsistent. The IRS estimates that workers only report around 45% of their tipped income. 

The compliance issues are made more challenging by the generally low wages in tip-dependent industries. The median annual income for waiters and waitresses in 2023 was $31,940, 24% lower than the national median personal income of $42,220, though exact incomes are difficult to track given underreporting. Roughly 37% of tipped workers earn so little that they owe no federal income tax at all. 

In 2023, the IRS implemented the Service Industry Tip Compliance Agreement (SITCA) program to increase tip reporting compliance using point-of-sale systems. While participation was voluntary, the program imposed greater paperwork burdens, expanded oversight, and removed the audit protections available under earlier compliance programs.

The new program raised concerns that it was targeting low-income earners despite a pledge from then-Secretary Janet Yellen that those earning less than $400,000 would not see increased enforcement under the $80 billion in funding provided to the IRS in the Inflation Reduction Act of 2022.

The controversies over enforcement helped push the issue into the 2024 presidential campaign. At a campaign event that June, Donald Trump called for no taxes on tips to provide relief to the hospitality industry. The policy was later adopted by Kamala Harris in her campaign. Both parties’ support for this proposal signaled bipartisan interest, but also competition for key swing states, particularly in Nevada, where tipped labor is common. 

The momentum for this policy was shown when Senator Ted Cruz’s (R-TX) No Tax on Tips Act passed the Senate 100-0 on May 20 this year. That level of bipartisan support is rare in today’s polarized environment and underscored the broad appeal of relieving tipped workers from additional tax burdens.

Overtime pay was also taxed at the same rate as regular wages prior to OBBBA. Under the Fair Labor Standards Act (FLSA), most hourly workers must receive time-and-a-half pay for hours worked beyond 40 hours per week. Trump first announced a “no tax on overtime” policy at a rally in Tucson, Arizona, on September 12, 2024, declaring, “. . . we will end all taxes on overtime. That gives people more of an incentive to work; it gives the companies a lot. It’s a lot easier to get the people.”

The Tipped Income Deduction in OBBBA

OBBBA creates a deduction for tipped income up to $25,000 per filer, with income limits of $150,000 for single filers and $300,000 for joint filers. This provision applies to federal income tax, not payroll taxes.

The new tipped income deduction will reduce federal revenues by $31.125 billion before it expires at the end of 2028.

The new law requires the Treasury Department to publish a list of qualifying tipped occupations by October 2, 2025. The list is to be based on workers that “customarily and regularly received tips on or before December 31, 2024.” The law also stipulates that tips must be paid voluntarily to qualify for the deduction.

The Overtime Income Deduction in OBBBA

OBBBA allows taxpayers to deduct up to $12,500 in overtime income for single filers and $25,000 for joint filers. Eligibility begins to phase out for single filers with modified adjusted gross income above $150,000 (or $300,000 for joint returns), with the deduction reduced by $100 for every $1,000 of income above those thresholds until it is phased out entirely. This deduction also ends after 2028.

This deduction applies to overtime wages defined by the FLSA as time-and-a-half pay over 40 hours. The law extends eligibility to certain independent contractors who are not covered under FLSA. Just as with no tax on tips, this applies to only federal income tax and not Social Security or Medicare payroll taxes. Under the FLSA, roughly 60% of the U.S. workforce, 97.7 million workers, are eligible for overtime. Yet, only 8% of hourly workers and 4% of salaried workers regularly work qualified overtime. Industries with the highest levels of overtime include healthcare, agriculture, forestry, transportation, and construction, and these are most likely to benefit from no tax on overtime.

The new overtime income tax deduction will reduce tax collections by $90 billion from 2025 through 2029.