Millions of U.S. workers who earn tips and overtime pay may find themselves eligible for a significant federal tax deduction starting with the 2025 income tax filings next year.
The potential beneficiaries of this tax break, however, are still uncertain as the government works out the specifics following President Donald Trump’s recent signature on a substantial spending and policy package.
This new legislation, signed by President Trump on July 4, requires the U.S. Treasury Department to publish an official list of occupations eligible for tax-free tips by October 2.
Additionally, the Treasury is expected to provide critical guidance on how to report tips and overtime pay, including the necessary documentation.
Though the deduction provisions are set to expire after the 2028 tax year, the potential advantages they provide could significantly impact many workers in the interim.
Currently, overtime pay is not separately itemized on employees’ W-2 forms, yet it typically appears in detail on employees’ pay stubs, as noted by Miguel Burgos, a certified public accountant with TurboTax.
Burgos advises employers to continue withholding taxes while awaiting further clarification, emphasizing that the bill does not affect state and local taxes or federal payroll taxes.
Eligible workers for tax-free tips are defined as those who have received tips on a regular basis prior to December 2024.
Notably, the restaurant industry alone employs around 2.1 million tipped servers and bartenders, as stated by the National Restaurant Association.
Barbers, hairdressers, nail technicians, and delivery drivers are also among the expected groups included in the eligibility.
To qualify, workers must report a Social Security number on their tax return and include a spouse’s Social Security number if filing jointly.
The legislation allows eligible workers to deduct up to $25,000 in tips if their income is below $150,000, or $300,000 for married couples filing jointly.
The amount deductible will diminish by $100 for every additional $1,000 earned over $150,000.
Approximately 40% of tipped workers currently pay little to no income tax, meaning they will not benefit from this change.
In contrast, the remaining 60% of tipped workers are projected to receive an average tax cut of $1,800 per year as a result of the new deductions.
Both cash tips and those received via credit card will count towards the deductions, along with pooled tips shared among employees in a restaurant setting.
However, service charges like automatic gratuities for large parties will not be included since the law specifies that eligible tips must be paid voluntarily.
On the front of overtime eligibility, the Budget Lab at Yale estimates about 8% of hourly workers and 4% of salaried workers are regularly compensated with overtime pay under the Fair Labor Standards Act.
This act mandates that employees must receive at least time-and-a-half pay after working 40 hours in a week.
It is important to note that positions such as clergy, teachers, and executives are exempt from these federal overtime regulations.
Workers will reportedly be allowed to deduct up to $12,500 in overtime pay on their federal tax returns, or $25,000 for joint returns.
Similar to the tip deductions, the deductible amount will decrease for those earning over $150,000 and necessitates the inclusion of a Social Security number on tax filings.
The average tax cut anticipated from the overtime deduction is estimated to range between $1,400 and $1,750 per year, as highlighted by the White House Council of Economic Advisers.
An analysis conducted by the nonpartisan Joint Committee on Taxation forecasts that implementing tax-free tips will lower federal revenue by about $31 billion from fiscal years 2026 to 2029, with tax-free overtime deductions projected to reduce revenue by approximately $90 billion in the same period.
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