Disclaimer: This article is for educational purposes only and is not tax, legal, or financial advice. Tax rules change periodically, always check current IRS guidance or consult a qualified tax professional.
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Quick Answer: Are Tips and Overtime Tax-Free in 2026?
Not entirely. The One Big Beautiful Bill Act (P.L. 119-21) created two new federal income tax deductions, not exclusions:
- Tip deduction (Sec. 224): Deduct up to $25,000 in qualified tips from federal taxable income.
- Overtime deduction (Sec. 225): Deduct up to $12,500 ($25,000 MFJ) in overtime premium pay.
Both are above-the-line deductions for tax years 2025 through 2028, whether you itemize or take the standard deduction. FICA taxes (Social Security 6.2% + Medicare 1.45%) and state/local income taxes still apply to all tip and overtime income.
Use the Tax Calculator US app to see how these deductions affect your federal refund.
Key Takeaways
- Deductions, not exclusions. Tips and overtime reduce your federal taxable income but remain subject to Social Security (6.2%), Medicare (1.45%), and state/local taxes.
- You can claim both on the same return. If you meet each deduction's eligibility requirements, you can take both. Tips deducted under Sec. 224 cannot also count as overtime under Sec. 225.
- Cap: $25,000 for tips, $12,500 for overtime. The overtime cap doubles to $25,000 on a joint return if both spouses qualify. Both deductions phase out starting at $150,000 MAGI ($300,000 MFJ).
- Overtime means only the premium portion. If you earn time-and-a-half, only the extra "half" above your regular rate qualifies. Your base rate for overtime hours stays fully taxable.
- Filed on Schedule 1-A. Both deductions are reported on the new Schedule 1-A (Parts II and III) and flow to Form 1040, line 13b.
- Temporary benefit. Both deductions apply to tax years 2025-2028 only. They expire after December 31, 2028, unless Congress extends them.
What "No Tax on Tips and Overtime" Actually Means
The phrase "no tax on tips and overtime" became a headline during the 2024 campaign season, but the law that passed works differently than the slogan suggests. The distinction between a deduction and an exclusion directly affects how much you save.
Deductions, not exclusions
The One Big Beautiful Bill Act (P.L. 119-21), signed July 4, 2025, created two new above-the-line deductions under IRC Sections 224 and 225. These deductions reduce your federal taxable income. They do not exclude tips or overtime from your gross income entirely.
Your tips and overtime are still reported as income. They still appear on your W-2. They are still subject to Social Security tax (6.2%), Medicare tax (1.45%), and any state or local income taxes your state imposes. The deductions only reduce what you owe in federal income tax.
Available to everyone, not just itemizers
Because these are above-the-line deductions, they reduce your adjusted gross income (AGI) before you choose between the standard deduction and itemizing. You can claim the standard deduction ($16,100 single / $32,200 MFJ for TY 2026) and the tip and overtime deductions on the same return.
Temporary provisions
Both deductions apply to tax years 2025 through 2028. They sunset after December 31, 2028, unless Congress passes an extension. Claim them each year while they're available.
No Tax on Tips: Who Qualifies and How Much You Can Deduct
The qualified tips deduction under IRC Section 224 lets eligible workers deduct up to $25,000 per year in tips from their federal taxable income.
Qualifying occupations
You must work in an occupation that customarily and regularly received tips before December 31, 2024. The IRS published a list of 68 qualifying occupations using Treasury Tipped Occupation Codes (TTOC). Examples include:
- Wait staff, bartenders, hosts/hostesses
- Salon workers (barbers, nail technicians, estheticians)
- Personal trainers and spa therapists
- Delivery drivers and gig economy workers
- Valets, bellhops, doormen, and hotel housekeeping
Your trade or business must not be a specified service trade or business (SSTB) under IRC Section 199A(d)(2). This excludes fields like law, accounting, consulting, and financial services.
What counts as a qualified tip
Only voluntary tips qualify. This includes cash tips, charged tips, and tip-pool distributions. Mandatory service charges added by your employer do not count. Tips are reported on your W-2 (Box 7 and, starting TY 2026, Box 12 code "TP"), on Form 4137 (unreported tips), or on 1099 forms for self-employed workers.
Self-employed tip earners
If you are self-employed, the deduction is capped at your net income from the trade or business where tips were earned, rather than the full $25,000. You must report tips on Schedule C and claim the deduction on Schedule 1-A.
Income phase-out
The deduction is reduced by $100 for every $1,000 of modified adjusted gross income (MAGI) above the threshold:
- Single: Phase-out begins at $150,000; fully eliminated at $400,000
- Married filing jointly: Phase-out begins at $300,000; fully eliminated at $550,000
For example, a single bartender with $200,000 MAGI loses $5,000 of the deduction (50 increments of $100), reducing the maximum from $25,000 to $20,000.
Other requirements
- A valid Social Security number is required on your return.
- Married taxpayers must file jointly to claim the deduction.
No Tax on Overtime: Who Qualifies and How Much You Can Deduct
The qualified overtime deduction under IRC Section 225 lets eligible hourly workers deduct up to $12,500 ($25,000 on a joint return if both spouses qualify) in overtime premium pay.
Only the premium portion qualifies
This trips up a lot of people. If you earn $20/hour and work overtime at time-and-a-half ($30/hour), only the extra $10/hour (the "half" above your regular rate) is deductible. Your base $20/hour for those overtime hours stays fully taxable.
The deduction covers the 0.5x premium, not the full 1.5x overtime rate. For double-time, you would deduct the 1x premium above the regular rate.
FLSA coverage is required
Only employees who are required to receive overtime under FLSA Section 7 qualify. What this means in practice:
- Hourly, non-exempt employees generally qualify.
- Salaried exempt employees (managers, professionals, executives under FLSA exemptions) generally do not qualify, even if they work more than 40 hours per week.
- Federal employees: Check SF-50, Block 35 for FLSA status. "N" means non-exempt (eligible); "E" means exempt (not eligible).
No double-dipping with tips
Tips that have already been deducted under the tip deduction (Sec. 224) cannot also be counted as qualified overtime compensation under Sec. 225. Each dollar of income can only be deducted once.
Income phase-out
The phase-out formula is the same as for tips: $100 reduction for every $1,000 of MAGI above the threshold. But because the overtime cap is lower ($12,500 vs. $25,000), it phases out faster:
- Single: Phase-out begins at $150,000; fully eliminated at $275,000
- Married filing jointly: Phase-out begins at $300,000; fully eliminated at $550,000
Other requirements
- Valid SSN required. Married filers must file jointly.
- Starting TY 2026, employers must report qualified overtime separately on W-2 Box 12, code "TT."
How Much Will You Actually Save?
Your savings depend on your marginal federal tax bracket. A deduction reduces your taxable income, so the tax savings equal the deduction amount multiplied by your marginal rate. Higher earners save more per dollar deducted, up to the phase-out.
Quick savings reference
| Marginal Bracket | $25,000 Tip Deduction Saves | $12,500 OT Deduction Saves |
|---|---|---|
| 10% | $2,500 | $1,250 |
| 12% | $3,000 | $1,500 |
| 22% | $5,500 | $2,750 |
| 24% | $6,000 | $3,000 |
Most tipped and hourly workers fall in the 10-22% brackets. Realistic savings range from about $1,000 to $5,500 depending on the deduction amount and bracket.
What FICA still takes
FICA taxes are not affected by either deduction. On $25,000 in tips, you still owe $1,912.50 in FICA (7.65% employee share). On $12,500 in overtime premium, FICA adds $956.25. The deductions only reduce the federal income tax portion.
See the examples section below for specific scenarios, or model your own numbers in the Tax Calculator US app.
How to Claim on Your Tax Return: Schedule 1-A Walkthrough
Both deductions are reported on the new Schedule 1-A (Additional Deductions), which attaches to your Form 1040, 1040-SR, or 1040-NR.
Schedule 1-A structure
The form has multiple parts. For tips and overtime, you will use:
- Part I: Calculate your Modified Adjusted Gross Income (MAGI) for phase-out purposes.
- Part II: Calculate your qualified tip deduction. Enter tips from W-2 Box 12 code "TP" (TY 2026+), 1099-NEC, 1099-MISC, 1099-K, or Form 4137.
- Part III: Calculate your qualified overtime deduction. Enter overtime premium from W-2 Box 12 code "TT" (TY 2026+).
- Part VI: Total all Schedule 1-A deductions and report on Form 1040, line 13b.
Step-by-step filing
- Gather your documents. You need your W-2 (look for Box 12 codes "TP" for tips and "TT" for overtime), pay stubs, and any 1099 forms if self-employed.
- Complete Part I. Calculate your MAGI to determine whether the phase-out applies. For most domestic filers, MAGI equals your adjusted gross income (AGI).
- Complete Part II (tips). Enter your total qualified tips. Apply the $25,000 cap and, if applicable, the phase-out reduction.
- Complete Part III (overtime). Enter your qualified overtime premium. Apply the $12,500 cap and any phase-out.
- Transfer to Form 1040. Add your totals from Part VI to line 13b of your 1040.
TY 2025 transition: what if your W-2 doesn't break out tips or overtime?
For tax year 2025, employers were not required to separately report tips or overtime premium on the W-2. If your W-2 lacks codes "TP" or "TT," use your pay stubs and the guidance in IRS Notice 2025-69 to estimate your qualified amounts. Keep your pay stubs as backup documentation.
Starting TY 2026, all employers must report qualified tips (Box 12, code "TP") and qualified overtime premium (Box 12, code "TT") separately on your W-2.
Adjusting your withholding during the year
You don't have to wait until filing season to benefit. Update your W-4 using Worksheet 4(b) to account for the expected deduction, and your employer will withhold less federal tax from each paycheck throughout the year.
Common Mistakes and What Still Gets Taxed
The "no tax" branding creates real confusion. These are the mistakes filers make most often with these deductions.
Mistake 1: Thinking tips and overtime are completely tax-free
They are not. FICA taxes (Social Security 6.2% + Medicare 1.45%) apply to every dollar of tip and overtime income. The deductions reduce only your federal income tax. For a worker earning $25,000 in tips, the FICA bill is still $1,912.50.
Mistake 2: Assuming your state follows the federal deduction
Most states have not adopted these deductions. As of early 2026, only eight states auto-conform to the federal tip deduction: Colorado, Idaho, Iowa, Michigan, Montana, North Dakota, Oregon, and South Carolina. Maine and Washington, D.C. have explicitly decoupled. Most states have not addressed the overtime deduction at all. Check your state's tax agency before assuming a state-level benefit.
Mistake 3: Salaried exempt employees claiming the overtime deduction
If your employer classifies you as FLSA exempt (salaried managers, professionals, executives), you do not qualify for the overtime deduction, even if you regularly work more than 40 hours per week. The deduction is strictly for workers entitled to overtime under FLSA Section 7.
Mistake 4: Including mandatory service charges as "tips"
An 18% automatic gratuity added by the restaurant is a service charge, not a tip. Only voluntary payments from customers qualify. The IRS has been clear about this distinction since Revenue Ruling 2012-18, and it carries over to the new deduction.
Mistake 5: Not filing jointly
Married taxpayers must file a joint return to claim either deduction. If you file married filing separately, both the tip and overtime deductions are disqualified entirely.
Mistake 6: Double-counting income across both deductions
If you receive tips and also work overtime, make sure the same dollars are not claimed under both deductions. Tips deducted under Sec. 224 cannot also be counted as overtime under Sec. 225.
Both deductions expire after 2028
These are temporary provisions for tax years 2025 through 2028. If Congress does not extend them, your 2028 return will be the last time you can claim these deductions.
Real-World Savings Examples
These examples use 2026 tax rates and were verified with Tax Calculator US. Your results will differ based on your complete tax situation.
A single server in Texas with $35,000 total income, including $20,000 in qualified tips:
- Qualified tips: $20,000
- Tip deduction claimed: $20,000 (below the $25,000 cap, no phase-out)
- Without deduction: Federal tax $2,020 | FICA $2,678 | Net $30,303
- With deduction: Federal tax $0 | FICA $2,678 (unchanged)
- Federal tax savings: ~$2,020
The tip deduction wipes out this server's entire federal income tax bill. FICA ($2,678) stays the same, and Texas has no state income tax. In a state like New York, state taxes would also remain unaffected.
A single hourly factory worker in Ohio earning $52,000 base pay plus $19,500 in total overtime (at time-and-a-half):
- Total income: $71,500
- Total overtime pay: $19,500
- Deductible OT premium (the 0.5x portion): $6,500
- Without deduction: Federal tax $6,900 | Ohio state $1,820 | FICA $5,470
- With deduction: Federal tax ~$5,620 | Ohio state $1,820 (unchanged) | FICA $5,470 (unchanged)
- Federal tax savings: ~$1,280
Only $6,500 of the $19,500 overtime pay is deductible (the premium portion). The base-rate portion ($13,000) remains fully taxable. Ohio state tax and FICA are not affected.
A married couple filing jointly in Florida with $90,000 combined income. One spouse is a nurse who earned $10,000 in overtime premium pay:
- Combined income: $90,000
- Qualified OT premium: $10,000
- OT deduction claimed: $10,000 (below the $12,500 cap, no phase-out)
- Without deduction: Federal tax $6,440 | FICA $6,885
- With deduction: Federal tax ~$5,240 | FICA $6,885 (unchanged)
- Federal tax savings: ~$1,200 (12% marginal bracket)
Florida has no state income tax. In a state with income tax, the state portion would stay the same because most states have not adopted the overtime deduction.
A single bartender in Nevada earning $42,000 total: $28,000 in wages, $12,000 in qualified tips, and $2,000 in overtime premium pay:
- Tip deduction: $12,000
- OT premium deduction: $2,000
- Total Schedule 1-A deductions: $14,000
- Standard deduction: $16,100
- Taxable income: $42,000 - $14,000 - $16,100 = $11,900
- Estimated federal tax savings: ~$1,670
Claiming both deductions together cuts this bartender's taxable income by $14,000 on top of the standard deduction. FICA on the full $42,000 ($3,213) stays the same. Nevada has no state income tax.
Frequently Asked Questions
Tips for Maximizing Your Deductions
- Keep every pay stub. For TY 2025, your W-2 may not separately list tips or overtime premium. Pay stubs are your backup documentation if the IRS questions your deduction. For TY 2026 and later, verify that Box 12 codes "TP" and "TT" on your W-2 match your records.
- Know the difference between tips and service charges. Voluntary tips qualify; mandatory service charges do not. If your restaurant adds an automatic 18% gratuity, that amount is not deductible under the tip provision. Only customer-initiated payments count.
- Calculate the overtime premium correctly. The deductible amount is only the portion above your regular rate. For time-and-a-half at $20/hour, only $10/hour qualifies. Multiply the premium rate by your overtime hours to find the deductible amount. Do not deduct the full overtime pay.
- Adjust your W-4 now instead of waiting until filing season. Use W-4 Worksheet 4(b) to account for your expected tip or overtime deduction. This reduces withholding throughout the year so you keep more in each paycheck rather than waiting for a refund.
- Check your FLSA status before claiming the overtime deduction. If you are salaried and classified as exempt, you do not qualify. Ask your employer or HR department for your FLSA classification. Federal employees can check SF-50, Block 35.
- Use the Tax Calculator US app to model your savings. Enter your income, tips, and overtime to see how both deductions affect your federal tax before you file.
References
- IRS: How to Take Advantage of No Tax on Tips and Overtime — Primary IRS guidance page covering both the tip and overtime deductions, including eligibility, caps, and phase-outs.
- IRS: Schedule 1-A, Additional Deductions -- What to Know — Official IRS overview of Schedule 1-A, the new form used to claim tip, overtime, car loan, and senior deductions.
- IRS: Questions and Answers About the Overtime Deduction — Official IRS FAQ covering FLSA eligibility, the premium-only rule, W-2 reporting requirements, and deduction caps.
- IRS: Guidance for TY 2025 Tips and Overtime Filers — Transition-year guidance for 2025 filers whose W-2 does not separately report tips or overtime premium.
- Paychex: 2025 Tax Law -- No Taxes on Overtime and Tips — Employer-perspective compliance guide covering state conformity details and W-2 reporting requirements.
- One Big Beautiful Bill Act (P.L. 119-21), Sections 70201-70202 — Full text of the legislation creating the tip and overtime deductions, including phase-out formulas and sunset provisions.