Federal Tax Deductions for Qualified Overtime and Tips: What Employers Need to Know

Part of a series | The One Big Beautiful Bill Act Series

Key takeaways

H.R.1, the One Big Beautiful Bill Act (the Act), includes a federal income tax deduction for "qualified overtime," effective for tax years 2025 through 2028.
The Act also includes a federal income tax deduction for "qualified tips," effective for tax years 2025 through 2028.
Employers with employees earning qualified overtime or qualified tips should communicate with employees about the changes.

Qualified overtime

Why is overtime still being taxed?

The Act includes a federal income tax deduction for "qualified overtime," effective for tax years 2025 through 2028. The Act didn't specifically create an exclusion from federal tax withholding, which is why overtime is still being taxed. Employees can claim the deduction on their individual federal tax return. Beginning January 1, 2026, employees are able to update their Federal Form W-4 to account for expected qualified overtime deductions. Employees use Worksheet 4(b) of the form to calculate the appropriate deduction amount to place on line 4(b) of the actual W-4.

In all cases, individuals may want to consult a tax advisor for further guidance on how to prepare their Form W-4.

Visit our employer resource center: Your guide to H.R.1, the One Big Beautiful Bill Act.

Is all overtime considered "qualified" for purposes of the federal tax deduction?

No. Under the Act, to meet the definition of "qualified overtime" for the federal tax deduction, the overtime pay must meet the following criteria:

1. 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) isn't eligible to be deducted.

2. Only the overtime premium portion of the overtime pay required by the FLSA qualifies for the deduction. 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 tax deduction. In this example, the other $10 of each overtime hour paid isn't eligible for the deduction.

Notes about qualified overtime:

Overtime eligible for the deduction is also limited to $12,500 (or $25,000, for married filing jointly).
The deduction phases out for higher-income individuals.
The Act's 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.
Depending on the location, overtime pay may also be subject to state and/or local taxes.

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 for that daily overtime also eligible for deduction?

No, as mentioned above, overtime pay must be required under Section 7 of the federal FLSA to qualify for the deduction. 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) isn't eligible to be deducted. Overtime pay after 8 hours of work in a day isn't required by Section 7 of the FLSA.

How does the overtime deduction phase out for higher-income individuals?

The overtime deduction phases out beginning when an individual's modified adjusted gross income (MAGI) exceeds $150,000 for the year (or $300,000, for married filing jointly).

Qualified tips

Why are tips still being taxed?

The Act also includes a federal income tax deduction for "qualified tips," effective for tax years 2025 through 2028. Like with qualified overtime, the Act didn't specifically create an exclusion from federal tax withholding, which is why tips are still taxed. Employees can claim a deduction on their individual federal tax return. Beginning January 1, 2026, employees are able to update their Federal Form W-4 to account for expected qualified tips deduction. Employees use Worksheet 4(b) of the form to calculate the appropriate deduction amount to place on line 4(b) of the actual W-4.

In all cases, individuals may want to consult a tax advisor for further guidance on how to prepare their Form W-4.

Are all tips considered "qualified?"

No. Under the Act, to be considered "qualified tips," the tips must be cash tips received by an individual in an occupation that customarily and regularly received tips on or before December 31, 2024.

Notes about tips:

Tips eligible for the deduction are also limited to $25,000.
Like the overtime deduction, the tips deduction phases out beginning when an individual's MAGI exceeds $150,000 for the year (or $300,000, for married filing jointly).
The Act's tips 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 tips.
Depending on the location, tips may also be subject to state and local taxes.

What occupations customarily and regularly received tips on or before December 31, 2024?

The Department of the Treasury and the Internal Revenue Service created a new list of three digit codes called the Treasury Tipped Occupation Code (TTOC) to identify the occupations which customarily and regularly receive tips on or before December 31, 2024. The three-digit code will be reported on workers year end Forms W-2 and Forms 1099. Workers will then be able to use the code to assist in claiming the deduction for qualified tips on their yearend tax returns.

Do tips received by credit card qualify for the deduction?

Some tips received by credit card may qualify for the deduction. "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 means mandatory service charges and mandatory gratuities (such as those a restaurant imposes on large parties) are excluded.

Note: Additional tips provided on top of mandatory service charges and mandatory gratuities may be includable as qualified tips. What employers should do next

Employers with employees earning qualified overtime or qualified tips should communicate 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. ADP is closely monitoring developments and will continue providing updates as more details emerge.

_{This article was originally published as an "ADP HR Tip of the Week," a communication created for ADP's}_{small business clients}_.