Two new deductions, not a full tax exemption
“No tax on tips” and “no tax on overtime” are new federal income tax deductions. They come from the One, Big, Beautiful Bill Act (OBBBA), signed July 4, 2025. They apply for tax years 2025 through 2028.
The name sounds broader than the rule. Tips and overtime are still reported as wages. You then subtract a capped amount when you figure taxable income. Social Security and Medicare tax still apply to every dollar, and state income tax rules vary.
Both deductions are claimed on the new Schedule 1-A. You can take them whether you use the standard deduction or itemize.
2026 limits and phase-outs at a glance
Each deduction has a yearly cap and an income phase-out. The phase-out uses modified adjusted gross income (MAGI).
| Rule | Qualified tips | Qualified overtime |
|---|---|---|
| Maximum deduction | $25,000 per return | $12,500; $25,000 married filing jointly |
| What counts | Tips in a customarily tipped occupation | Premium portion of FLSA overtime only |
| Phase-out starts (MAGI) | $150,000; $300,000 joint | $150,000; $300,000 joint |
| Phase-out rate | $100 per $1,000 over | $100 per $1,000 over |
| Married filing separately | Not allowed | Not allowed |
| Social Security and Medicare | Still owed | Still owed |
| Years available | 2025–2028 | 2025–2028 |
Sources: IRS release on Schedule 1-A and IRS 2026 inflation adjustments. Also see IRS fact sheet FS-2025-03.
Who can deduct tips
The tips deduction covers workers in jobs where tipping is customary. The IRS publishes a list of qualifying occupations, such as many food, beverage and personal service roles.
- Occupation: the job must be on the IRS list of customarily tipped occupations.
- Valid SSN: you need a valid Social Security number.
- Joint return if married: married couples must file jointly to claim it.
- Records: tips should be reported to your employer or on your return. Unreported cash tips are a weak base for any deduction.
Self-employed workers in listed occupations may also qualify, with extra limits. Check the IRS guidance for your specific job.
The deduction applies to qualified tips you actually received, whether paid in cash, by card or through a tip pool. It does not cover service charges that a business adds to a bill automatically. Those are generally treated as regular wages, not tips.
The $25,000 cap applies per return, not per job. A worker with two tipped jobs shares one cap across both. On a joint return, the cap is also $25,000 in total.
Overtime: only the premium portion counts
The overtime deduction does not cover your whole overtime paycheck. It covers only the extra “half” in time-and-a-half pay that the Fair Labor Standards Act (FLSA) requires.
Say your regular rate is $30 per hour. Overtime pays $45 per hour. The first $30 of each overtime hour is regular pay. Only the $15 premium can be deducted.
The overtime must be required by the FLSA, which generally means hours over 40 in a workweek for nonexempt employees. Extra pay that only a union contract or company policy requires, such as daily overtime or double time, may not fully count. Employers are expected to report qualified overtime separately, so check your W-2 or year-end pay statement.
Salaried workers who are exempt from FLSA overtime rules generally have no qualified overtime to deduct. That often includes many managers and professionals. If your employer pays you extra for long weeks anyway, that pay may not meet the FLSA test.
How the deduction shows up during the year
Your paycheck may not change. Employers still withhold federal income tax on tips and overtime as usual. The benefit generally arrives when you file, as a lower tax bill or a larger refund. Some workers may choose to adjust their Form W-4 to reflect the expected deduction.
Worked examples
Example 1: a server’s tips deduction
A single server earns $42,000 in wages plus $18,000 in reported tips in 2026. Her MAGI is $60,000, well under the phase-out. She takes the $16,100 standard deduction.
- Without the tips deduction: $60,000 − $16,100 = $43,900 taxable.
- Tax: $1,240 + 12% × ($43,900 − $12,400) = $5,020.
- With the deduction: $43,900 − $18,000 = $25,900 taxable.
- Tax: $1,240 + 12% × ($25,900 − $12,400) = $2,860.
- Income tax saved: $5,020 − $2,860 = $2,160.
Her tips still face Social Security and Medicare tax: 7.65% × $18,000 = $1,377. The deduction does not change that. Those payroll taxes also count toward her future Social Security benefits, so the earnings record is unchanged.
Why are the savings $2,160 rather than more? Her income stays in the 12% bracket in both cases, so each deducted dollar saves 12 cents. A worker in a higher bracket would save more per dollar deducted.
Example 2: overtime premium
A single warehouse worker earns $30 per hour for 2,080 regular hours, or $62,400. He also works 200 FLSA overtime hours at $45, for $9,000. Total wages are $71,400.
- Qualified premium: 200 hours × $15 = $3,000.
- Taxable income before the deduction: $71,400 − $16,100 = $55,300.
- After the deduction: $55,300 − $3,000 = $52,300.
- Both amounts are in the 22% bracket, so the saving is 22% × $3,000 = $660.
The remaining $6,000 of his overtime pay, the straight-time part, is taxed like any other wages. If he worked the same hours with no overtime premium, he would have no deduction at all.
Example 3: tips deduction with a phase-out
A married couple files jointly. Their MAGI is $320,000, and one spouse has $28,000 in qualified tips.
- Income over the threshold: $320,000 − $300,000 = $20,000.
- Reduction: 20 × $100 = $2,000.
- Reduced cap: $25,000 − $2,000 = $23,000.
- Deduction allowed: the smaller of $28,000 or $23,000 = $23,000.
The other $5,000 of tips stays taxable. At this rate of $100 per $1,000, the $25,000 tips cap is fully gone at $550,000 MAGI for a joint return.
The same phase-out math applies to overtime. A couple filing jointly with $310,000 of MAGI is $10,000 over the threshold. Their $25,000 overtime cap drops by 10 × $100 = $1,000, to $24,000. For incomes that fall between $1,000 steps, the Schedule 1-A instructions explain the exact calculation.
Two more deductions from the same law
OBBBA added two other temporary deductions, also on Schedule 1-A for 2025–2028.
- Senior deduction: $6,000 per person age 65 or older, or $12,000 if both spouses qualify. It is reduced by 6% of MAGI above $75,000 ($150,000 joint). Married couples must file jointly. It is on top of the regular extra standard deduction for age 65+.
- Car loan interest: up to $10,000 of interest on a loan for a qualifying new, personal-use vehicle assembled in the United States.
Senior deduction example: a single filer age 67 has MAGI of $85,000. That is $10,000 over the $75,000 threshold. The reduction is 6% × $10,000 = $600, so the senior deduction is $6,000 − $600 = $5,400.
All four deductions are scheduled to end after the 2028 tax year unless Congress extends them. They also lower taxable income, not adjusted gross income, so they generally do not change AGI-based limits for other credits and deductions. Tracking your tips, overtime premium and vehicle loan statements through the year makes filing simpler.
Because these rules are new, IRS forms and guidance may be updated. Reviewing the Schedule 1-A instructions or asking a tax professional can help confirm eligibility.
See the effect on your return
To estimate how a tips or overtime deduction changes your bill, enter your figures in the Federal Income Tax Calculator. You can also see how much lands in each bracket with the Tax Bracket Calculator. Both give federal estimates only.