The Ledger: “No Tax on Tips” and “No Tax on Overtime” – Why the Wording Matters

Molly Shattuck, CPA
Director

You’ve likely seen the headlines: “No tax on tips” and “No tax on overtime”. While those phrases sound appealing, they can be misleading. Tips and overtime are not tax-free. Instead, the One Big Beautiful Bill Act (“OBBBA”) created two temporary federal income tax deductions – not exclusions from income – for taxpayers who meet specific requirements.  

What This Means in Practice 

Despite the headlines: 

• Tips and overtime pay are still taxable income and generally still reported on your W-2. 

• Employers will generally continue withholding federal income tax from paychecks as usual. 

• If you qualify, you may be able to claim a federal income tax deduction on your tax return that reduces the amount of income subject to federal tax. 

Not all taxpayers, or types of tips or overtime, will qualify. There are income limits, reporting requirements, and definitions that must be met.  

Deduction for Qualified Tips 

• Qualified tips for are voluntary payments from customers and must be received in fields that “customarily and regularly” receive tips (waitstaff, hair stylists, bartenders, “gig economy” workers, etc.).  

• What does not qualify? Mandatory service charges or automatic gratuities do not count as qualified tips. 

• Maximum deduction: up to $25,000 per return per year. 

• Income phaseout: the deduction is reduced as your income increases, starting at $150,000 of modified adjusted gross income (MAGI) ($300,000 if married filing jointly). 

Deduction for Qualified Overtime 

• Qualified overtime is the premium portion of overtime pay – the “half” in time-and-a-half – that is required by the Fair Labor Standards Act (FLSA). The FLSA requires overtime pay for hours worked over 40 in a workweek.  

• What does not qualify? Bonuses, shift differentials, or overtime paid outside FLSA requirements generally do not qualify. 

• Maximum deduction: up to $12,500 per year ($25,000 if married filing jointly). 

• Income phaseout: the deduction is reduced as your income increases, starting at $150,000 MAGI ($300,000 if married filing jointly). 

Reporting  

For 2026-2028, employers must report qualified tips and overtime on employee W-2s using new Box 12 codes to facilitate tax deductions. Box 14 of the W-2 will also be used to report the applicable tipped occupation code. Under current law, these deductions are set to expire after 2028.  

If you are an employer, make sure that your payroll system is properly set up to report these items correctly in 2026. Remember, it is likely that not all tips or overtime are “qualified” and eligible for a tax deduction. You may need to create additional pay items to correctly separate qualified versus non-qualified tips/overtime pay.  

If you are an employee that receives tips and/or overtime, it is important that you understand the rules and agree with the method your employer is using to calculate and report qualified tips/overtime.  

Bottom line 

Despite the headlines, there is technically no such thing as “no tax on tips” or “no tax on overtime.” Instead, there is a temporary federal tax deduction that may provide tax savings – but only if the rules are followed carefully. Because these provisions are nuanced and time-limited, coordination between payroll reporting and tax filing is essential. Employers and taxpayers should consult with their payroll and tax professionals to ensure these items are reported – and potentially deducted – correctly.