What the 2025 law actually changed
Public Law 119-21, signed on July 4, 2025 and commonly known as the One Big Beautiful Bill Act, added two sections to the Internal Revenue Code: section 224, qualified tips, and section 225, qualified overtime compensation. Both are deductions from income subject to federal income tax:
- They apply to tax years 2025, 2026, 2027 and 2028, and end after December 31, 2028.
- You can take them whether you itemize or use the standard deduction. You claim them on the new Schedule 1-A, Additional Deductions, explained by the IRS.
- Your tips and overtime are still income. They still appear on your Form W-2 or 1099, and federal income tax is still withheld unless you update your Form W-4.
- They do not touch Social Security, Medicare or state income tax.
Who qualifies for the tips deduction
Section 224 lets you deduct qualified tips if all of these are true:
- The tips are cash tips: paid in cash or charged to a card, or received through a tip-sharing arrangement if you are an employee.
- They are voluntary: the customer decides the amount, there is no consequence for not paying it and it is not negotiated. Mandatory service charges added to the bill are not qualified tips, says IRS Publication 15.
- You work in an occupation that customarily and regularly received tips on or before December 31, 2024, as listed by the Treasury and the IRS.
- The tips are on a W-2, a 1099 or another statement given to you, or you report them on Form 4137.
- The business is not a specified service trade or business under section 199A. If you are an employee, your employer’s business counts.
If you are self-employed, the deduction cannot be more than your net income from the business where you earned the tips.
Who qualifies for the overtime deduction
Section 225 covers only the overtime that the Fair Labor Standards Act requires, and only the part above your regular rate: the "half" in time and a half. It is not the whole overtime check.
At $20 an hour, a 50-hour week pays 10 overtime hours at $30. Of that $300, only $100 (10 hours × the $10 premium) is qualified overtime compensation. Twenty weeks like that add $6,000 of overtime pay and $2,000 of deductible premium, as our overtime calculator shows.
Overtime that the FLSA does not require, such as daily overtime or double time paid under a state law, a union contract or company policy, falls outside the definition. Exempt employees, who are not owed FLSA overtime, do not have qualified overtime either.
Limits and phase-outs
| Tips (section 224) | Overtime (section 225) | |
|---|---|---|
| Maximum deduction per year | $25,000 per return | $12,500, or $25,000 on a joint return |
| Phase-out starts at modified AGI of | $150,000, or $300,000 joint | $150,000, or $300,000 joint |
| Reduction | $100 per $1,000 over | $100 per $1,000 over |
Both deductions also require a valid Social Security number on the return, and married taxpayers must file jointly. Two examples of the phase-out:
- A single filer with $180,000 of modified AGI is $30,000 over, so the overtime cap drops by $3,000, from $12,500 to $9,500.
- A single filer with $160,000 is $10,000 over, so the tips cap drops by $1,000, to $24,000.
Social Security, Medicare and withholding still apply
IRS Publication 15 for 2026 is clear: tips are still generally subject to both the employee and employer share of Social Security and Medicare tax when they reach $20 or more in a month, and overtime is still generally subject to both as well. Your employer keeps withholding 6.2% for Social Security and 1.45% for Medicare.
Federal income tax withholding does not change by itself either. The 2026 Form W-4 was updated for the new deductions, and Publication 15-T tells employers to use it, so you can claim your expected deduction there and get more in each paycheck instead of waiting for your refund.
How much it saves: two examples
We checked both with our income tax calculator for 2026, single filer, standard deduction:
- Server with $48,000 of income, $18,000 of it qualified tips. Federal income tax falls from $3,580 to $1,420: $2,160 less. Social Security and Medicare on the $18,000 of tips stay at $1,377 (7.65%).
- Worker with $47,600 of income, $2,000 of it FLSA overtime premium. Federal income tax falls from $3,532 to $3,292: $240 less, 12% of $2,000. Social Security and Medicare on the full $6,000 of overtime pay stay at $459.
The deduction saves what your top bracket rate says: 10% or 12% for most hourly workers. If your income is low enough that you already owe little or no federal income tax, the deduction may save you little or nothing.
Official sources
- 26 U.S.C. § 224: qualified tips deduction · qualified tips: limit, phase-out, definition, termination after 2028
- 26 U.S.C. § 225: qualified overtime compensation deduction · qualified overtime compensation: limit, phase-out, definition
- IRS: One Big Beautiful Bill Act tax deductions for working Americans and seniors · IRS fact sheet FS-2025-03
- IRS: Working Families Tax Cuts, provisions for individuals and workers · eligibility and Schedule 1-A
- IRS Publication 15 (2026): Employer's Tax Guide · Social Security and Medicare on tips and overtime; service charges
- IRS Publication 15-T (2026): Federal Income Tax Withholding Methods · 2026 Form W-4 and withholding
- Fair Labor Standards Act, 29 U.S.C. § 207: maximum hours and overtime · overtime after 40 hours at 1.5 times the regular rate