What Employers Need to Know About No Tax on Tips and No Tax on Overtime

On July 3, 2025, the U.S. House of Representatives narrowly passed H.R.1, the so-called “One Big Beautiful Bill Act,” ending a dramatic journey through Congress that dominated headlines in recent weeks. President Donald J. Trump is expected to sign the bill into law on July 4. The Act is intended to be the Trump administration’s marquee legislation leading up to the 2026 midterm elections. It includes several provisions related to campaign promises made by then-candidate Trump. This ASAP explains two of the campaign’s more populist campaign promises that were incorporated into the final legislation: “no tax on tips” and “no tax on overtime.” 

No Tax on Tips

Section 70201 of the Act establishes a new above-the-line tax deduction for “qualified tips.”¹ The following conditions apply:

1. The deduction is capped at $25,000 per year. This amount is reduced by $100 for each $1,000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return).
2. To be considered a “qualified tip,” the amount must: (a) be paid voluntarily without any consequence in the event of nonpayment; (b) not be the subject of negotiation; and (c) be determined by the payor. Thus, for example, a mandatory service charge imposed by the employer for a banquet will not qualify for the deduction, and neither will a required gratuity that a restaurant adds automatically to a bill for large parties. Failing to make this distinction may lead employees to claim deductions to which they are not entitled.
3. While the deduction applies to “cash” tips only, the Act broadly defines “cash” tips to include tips paid in cash or charged, as well as tips received by an employee under a tip-sharing arrangement. This definition excludes tips that are “non-cash,” such as tangible items like a gift basket or movie tickets.
4. To qualify for the deduction, the tips must be received by an individual engaged in an occupation that customarily and regularly received tips on or before December 31, 2024. This limitation appears designed to deter employers outside the hospitality and service industries from recharacterizing a portion of their employees’ existing incomes as “tips” in an attempt to take advantage of the new deduction. The Act requires the Treasury secretary, within 90 days, to publish a list of qualifying occupations.
5. The qualified tips must be reported on statements furnished to the individual as required under various provisions of the Internal Revenue Code (such as the requirement to issue a Form W-2) or otherwise reported by the taxpayer on Form 4137 (Social Security and Medicare Tax on Unreported Tip Income). Of course, employees and employers have long been required to report 100% of all tips received to the IRS – including tips received in cash, via a charge on a credit card, and through a tip-sharing arrangement – and the Act does not change that reporting requirement. It remains to be seen whether the Act will encourage tipped employees to more readily report tips paid in cash, considering that such reported tips may still be subject to state and local taxation.
6. A tip does not qualify for deduction if it was received for services: (a) in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services; (b) in any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners; or (c) that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities.
7. In the case of qualified tips received by an individual engaged in their own trade or business (not as an employee), the deduction cannot exceed the taxpayer’s gross income from such trade or business.
8. The deduction is not allowed unless the taxpayer includes their social security number (and, if married and filing jointly, their spouse’s social security number) on their tax return.

The Act requires employers to include on Form W-2 the total amount of cash tips reported by the employee, as well as the employee’s qualifying occupation. For 2025, the Act authorizes the reporting party to “approximate” the amount designated as cash tips pursuant to a “reasonable method” to be specified by the Treasury secretary.

The Act authorizes the secretary to: (a) establish other requirements to qualify for the deduction beyond those set forth in the Act; and (b) promulgate regulations and provide guidance to prevent reclassification of income as qualified tips and to otherwise “prevent abuse” of this deduction. The “no tax on tips” deduction takes effect for the 2025 tax year and is set to expire after the 2028 tax year.

With all the discussion around the “no tax on tips” legislation, employers may consider revamping their “tip pool” arrangements, encouraging customers to tip even in scenarios where tipping was not customary, or otherwise expanding their reliance on tips, in an attempt to get more tip income into the pockets of more employees. Federal (and often state and local) rules regarding who may participate in a tip pool are strict, however, and failing to comply with them can prove costly. Until the Treasury secretary promulgates regulations and provides further guidance about what qualifies for the deduction on qualified tip income, employers should tread carefully.

No Tax on Overtime

Section 70202 of the Act creates an above-the-line tax deduction for “qualified overtime compensation.” Qualified overtime compensation is defined as “overtime compensation paid to an individual required under section 7 of the Fair Labor Standards Act of 1938 [FLSA] that is in excess of the regular rate ... at which such individual is employed.” The following conditions apply:

1. The deduction is capped at $12,500 ($25,000 in the case of a joint return) in any taxable year. This amount is reduced by $100 for each $1,000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return).
2. The deduction applies only to overtime compensation that is “required” under the FLSA and only to the amount that is in “excess” of the employee’s “regular rate.”² The deduction does not apply to overtime premiums that are not “required” by the FLSA but instead are paid pursuant to contract (including a collective bargaining agreement) or because they are required under state law only (e.g., California law requiring daily overtime for hours worked in excess of eight in one day).
3. In an apparent attempt to prevent “double dipping” on these deductions, the Act clarifies that qualified tips cannot also be claimed as qualified overtime compensation.
4. As with the deduction for qualified tip income, the deduction is not allowed unless the taxpayer includes their social security number (and, if married and filing jointly, their spouse’s social security number) on their tax return.

Critically, employers must include the total amount of qualified overtime compensation as a separate line item on the Form W-2. This will require employers to keep a distinct record of the overtime premium compensation that is both (a) required under the FLSA and (b) in excess of the regular rate.³ For 2025, the Act authorizes the reporting party to “approximate” the amount designated as qualified overtime compensation pursuant to a “reasonable method” to be specified by the Treasury secretary.

The Act authorizes the secretary to promulgate regulations and issue guidance to “prevent abuse” of this deduction. The “no tax on overtime” deduction takes effect for the 2025 tax year and is set to expire after the 2028 tax year.

Employers may consider whether to restructure employee classifications or hours reporting to push more earnings into overtime compensation. Employers should exercise extreme caution and consult legal counsel before implementing any compensation changes designed to take advantage of this deduction. Many of the schemes that have been discussed are fraught with risk. As just two examples:

1. Employers may be considering converting certain salaried exempt employees to hourly nonexempt status and paying them at an artificially low hourly rate, with the rest of their weekly earnings being designated as “overtime” compensation. For an employee classified as nonexempt under the FLSA, however, the employer must keep an accurate record of all hours worked by the employee and must calculate overtime based on actual hours worked. The employer cannot record a fictitious number of overtime hours designed to generate total weekly wages equal to the employee’s former weekly salary, regardless of actual hours worked.
2. For their existing non-exempt employees, employers may consider reducing their hourly rates and pushing more of their earnings into “overtime” compensation (e.g., by triggering overtime at 30 hours, or by paying double-time for hours over 40). One challenge of this approach is that the deduction only applies to overtime premiums that are “required” by the FLSA, not to all compensation designated as “overtime” by a creative employer.

Final Thoughts

The “no tax on tips” and “no tax on overtime” provisions are likely to be popular with many employees across the country, especially hospitality and service industry workers who depend heavily on tips for much of their income and employees who routinely work significant amounts of overtime. However, these new deductions bring their own set of challenges for employers.

Employers navigating the new Form W-2 reporting requirements or who may be considering restructuring employee compensation in consideration of the “no tax on tips” and “no tax on overtime” provisions of the Act are encouraged to consult with experienced employment counsel to make certain that they consider all relevant factors in their decision making.