Tax Breaks for Tipped Workers and Overtime: What You Need to Know
Millions of workers in the U.S. who earn tips and overtime pay might qualify for new federal tax deductions when they file their 2025 income taxes. This comes after President Donald Trump’s recent spending package aimed to assist those in the service industry.
The U.S. Treasury Department is tasked with specifying which occupations will qualify for these tax-free tips. They are expected to release a list by October 2, along with guidelines on how to report tips and overtime pay.
While these tax deduction provisions are beneficial, they are not permanent and will expire after the 2028 tax year. Currently, overtime pay is not separately listed on an employee’s W-2 tax form, but employers keep track of it on pay stubs. Experts advise that employers should continue to withhold taxes until further guidance is provided. It’s important to note that these tax changes do not apply to state or local taxes or federal payroll taxes, which help fund Social Security and Medicare.
Who Qualifies for Tax-Free Tips?
Eligible workers are those who regularly received tips before December 2024. In the restaurant sector alone, there are about 2.1 million tipped employees, including servers and bartenders. Other roles, such as barbers and delivery drivers, are also expected to be covered. To qualify, workers must provide a Social Security number when filing taxes, and married workers must include their spouse’s number if filing jointly.
Deduction Amounts
Workers making under $150,000 (or $300,000 if married filing jointly) can deduct up to $25,000 in tips. The deduction decreases by $100 for every $1,000 earned above the $150,000 threshold.
Who Gains the Most?
It’s estimated that around 40% of tipped workers will not see a change as they already do not pay much in income tax. The remaining 60% could benefit from an average tax cut of about $1,800 annually.
What Types of Tips Count?
Both cash and credit card tips are eligible. Tips that are pooled and then shared among staff are included too. However, automatic service charges for large parties are not counted, as the bill specifies that eligible tips must be given voluntarily.
Tax-Free Overtime Eligibility
About 8% of hourly workers and 4% of salaried employees regularly receive overtime pay as mandated by the Fair Labor Standards Act. However, certain professions, such as teachers and executives, are exempt from federal overtime rules.
Overtime Deductions
Workers can deduct up to $12,500 in overtime, or $25,000 for joint returns. Similar to the tip deductions, the amount decreases for those earning above $150,000.
Expected Tax Cuts from Overtime Deductions
The average worker might see a tax reduction between $1,400 and $1,750 per year. However, according to a nonpartisan analysis, the introduction of tax-free tips and overtime is projected to reduce federal revenue significantly over the next few fiscal years.
In summary, these new tax provisions are designed to provide relief to workers in the service industry, enhancing their financial well-being as they navigate their careers.
