Millions of U.S. workers who earn tips and receive overtime pay could be eligible for new federal tax deductions when they file their 2025 income taxes next year.
Under a bill signed into law by President Donald Trump on July 4, the U.S. Treasury Department is tasked with publishing a list of occupations that qualify for these tax-free tips by October 2.
Details regarding how to report tips and overtime pay, as well as the required documentation for the new deductions, are still being finalized.
The deductions for tax-free tips and overtime are scheduled to expire following the 2028 tax year.
As it stands, overtime pay is not currently itemized separately on an employee’s W-2 tax form, but employers track and itemize it on pay stubs.
Certified Public Accountant Miguel Burgos, who works with TurboTax, advises that employers should continue withholding taxes while guidance is awaited.
It is important to note that the new legislation does not impact state and local taxes or federal payroll taxes, which are used to fund Social Security and Medicare.
Regarding tax-free tips, eligible workers must already receive tips regularly before December 2024.
According to the National Restaurant Association, there are approximately 2.1 million tipped servers and bartenders in the restaurant industry who are expected to qualify.
Additionally, barbers, hairdressers, nail technicians, and delivery drivers are also anticipated to be included in this category.
To qualify, workers must provide a Social Security number when filing their taxes, along with a spouse’s Social Security number if they are married and filing jointly.
Eligible workers can deduct up to $25,000 in tips if their income is less than $150,000; this amount increases to $300,000 for married couples filing jointly.
For income exceeding $150,000, the deductibility of tips is reduced by $100 for every $1,000 earned.
However, around 40% of tipped workers may not see a significant effect from this change because they already pay little to no income tax, as noted by the nonpartisan Tax Policy Center.
Conversely, the other 60% of tipped workers are projected to benefit from an average tax cut of approximately $1,800 per year through the new deductions.
Both cash tips and credit card tips will be included in this deduction calculation.
Tips that are pooled and subsequently distributed among employees are also eligible, though this might lead to reduced participation in tip pooling, as servers will now appreciate the tax deduction availability.
It is also important to clarify that service charges, such as automatic gratuities for large parties, are not included because the bill specifically states that eligible tips must be “paid voluntarily.”
Additionally, the legislation addresses tax-free overtime for a segment of U.S. workers.
The Budget Lab at Yale estimates that about 8% of hourly workers and 4% of salaried employees regularly receive overtime pay under the Fair Labor Standards Act.
This law mandates that employees must receive at least time and a half for hours worked over 40 in a week, although certain professions, including clergy, teachers, and executives, are exempt from these federal overtime rules.
Workers may deduct up to $12,500 in overtime, which doubles to $25,000 for joint filers.
Similar to tip deductions, the amount of overtime that qualifies for deduction will decrease for workers earning more than $150,000.
To be eligible, workers must again provide their Social Security number when filing.
An expected outcome for workers taking advantage of the overtime deductions is a tax cut ranging between $1,400 and $1,750 annually, as estimated by the White House Council of Economic Advisers.
The projected fiscal impact of these tax-free tips is a reduction in federal revenue by $31 billion from 2026 to 2029.
On the other hand, tax-free overtime is expected to reduce federal revenue by $90 billion during the same period.
As the deadline for Treasury Department guidance approaches, many are keenly awaiting further details on these significant changes.
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