H.R.1 Impacts to Taxes on Overtime and Tips: What Employers Need to Know
Part of a series | The One Big Beautiful Bill Act Series
H.R.1, the One Big Beautiful Bill Act (the Act), was signed into law July 4, 2025. The Act includes several changes that will impact payroll, employment taxes, and employee benefits. Below, we answer frequently asked questions about changes in the tax treatment of overtime and tips made by the Act.
For more details on these and other provisions of the Act, please visit ADP's Eye on Washington update. ADP will closely monitor developments and provide updates as more details emerge.
Overtime
Q: What changes did the Act make to how overtime is treated for federal tax purposes?
A: The Act includes a federal income tax deduction for "qualified overtime", effective for tax years 2025 through 2028. The deduction will be claimed on individual federal tax returns and is retroactive to January 1, 2025.
Q: To which taxes does the qualified overtime deduction apply?
A: The overtime deduction applies only to federal income taxes, so individuals and employers remain responsible for deducting and paying applicable Medicare and Social Security taxes with respect to qualified overtime.
Q: What overtime qualifies for the deduction?
A: Overtime eligible for the deduction is limited to $12,500 (or $25,000, for married filing jointly). Under the Act, the overtime must meet the definition of "qualified overtime." To meet this definition:
- The overtime pay must be required under Section 7 of the federal Fair Labor Standards Act (FLSA) (Overtime not required by the FLSA (such as potentially more generous overtime required under state laws, a collective bargaining agreement or paid voluntarily by employers) is not eligible to be deducted.); and
- Only the overtime premium portion of the overtime pay required by the FLSA would qualify for the deduction.
Q: What is the overtime premium portion of overtime pay?
A: Under the FLSA, employers must pay nonexempt employees (employees eligible for overtime) 1.5 times their regular rate of pay whenever they work more than 40 hours in a workweek. For example, if an individual is paid $10 per hour for non-overtime earnings, and $15 per hour for overtime, only the $5 per hour premium pay for overtime is eligible for the new tax deduction..
Q: If I pay overtime in more circumstances than required by the FLSA, such as after 8 hours of work in a day as required by state law or a collective bargaining agreement, is the overtime premium portion earned by an employee also eligible for deduction?
A: No, as mentioned above, the overtime pay must be required under Section 7 of the federal FLSA to qualify for the deduction. Overtime pay after 8 hours of work in a day isn't required by Section 7 of the FLSA.
Q: Does the overtime deduction phase out for higher-income individuals?
A: The overtime deduction will phase out beginning when an individual's modified adjusted gross income (MAGI) exceeds $150,000 for the year (or $300,000, for married filing jointly).
Q: Must an individual itemize deductions to be eligible for the overtime deduction?
A: No, the overtime deduction is available regardless of whether an individual chooses to itemize deductions or take the standard deduction.
Tips
Q: What changes did the Act make to how tips are treated for federal tax purposes?
A: The Act includes a federal income tax deduction for qualified tips, effective for tax years 2025 through 2028. The deduction will be claimed on individual tax returns and is retroactive to January 1, 2025.
Q: To which taxes does the tips deduction apply?
A: The deduction applies only to federal income taxes, so individuals and employers remain responsible for deducting and paying applicable Medicare and Social Security taxes, as well as any applicable state income taxes, with respect to qualified tips.
Q: What tips qualify for the deduction?
A: Tips eligible for the deduction are limited to $25,000. The tips must meet the definition of "qualified tips." Under the Act, this means cash tips received by an individual in an occupation that customarily and regularly received tips on or before December 31, 2024.
Q: Do tips received by credit card qualify for the deduction?
A: "Cash tips" for purposes of the Act include tips received from customers that are paid in cash or charged and, in the case of an employee, tips received under any tip-sharing arrangement.
The amount must be paid and determined voluntarily by the payor without any consequence in the event of nonpayment and cannot be the subject of negotiation. This would exclude, for example, mandatory service charges and mandatory gratuities (such as those a restaurant imposes on large parties).
Q: What occupations customarily and regularly received tips on or before December 31, 2024?
A: The Act requires the U.S. Department of the Treasury to release a list of qualifying occupations within 90 days of enactment. Workers in certain specified businesses are already excluded from the tips deduction, such as those providing services in accounting, health, law, actuarial science, athletics, brokerage services, consulting, financial services or the performing arts.
Q: Does the tips deduction phase out for higher-income individuals?
A: Like the overtime deduction, the tips deduction will phase out beginning when an individual's MAGI exceeds $150,000 for the year (or $300,000 for married filing jointly).
Q: Must an individual itemize deductions to be eligible for the tips deduction?
A: No, the deduction is available regardless of whether an individual chooses to itemize deductions or take the standard deduction.
Conclusion
Employers with employees earning qualified overtime or qualified tips should begin communicating with employees about the changes. Employers should also watch for more information and updates as it is released in ADP's H.R.1 Resource Center. A recent webcast is now available for viewing on demand, along with several other resources.
This article was originally published as an "ADP HR Tip of the Week," a communication created for ADP's small business clients.
