Key Takeaways
- Boosted take-home pay: Eligible workers can now deduct qualified tip income (up to $25,000) and overtime premiums (up to $12,500) from federal taxable income through 2028, increasing net earnings.
- Who qualifies: The deductions apply to tipped workers (like servers and drivers) and overtime earners (like nurses, factory workers, and public safety staff), with income limits and phase-outs.
- Plan for side effects: While taxes on tips and overtime are reduced, these deductions don’t affect payroll taxes, and may lower reported income for loans, credit, or benefits eligibility.
- Tax planning advantage: Strategic planning can help you balance the benefits of lower taxable income with potential impacts on financial assessments.
When the government enacted the One Big Beautiful Bill (OBBB) Act, many people assumed the main changes would be felt by businesses. But the Act affects everyday workers, too. And especially those who earn tips and overtime.
Under new legislation, you can now deduct qualified tip income and overtime pay from your federal taxable income annually through 2028. In this blog, we’ll walk you through the changes, how they impact you, and how to ensure you make the most of your tips and overtime.
What Has Changed Around Taxation of Tips and Overtime?
In a nutshell, the “No Tax on Tips” provision, allows you to deduct tips, if you earn up to $160,000 annually in traditionally tipped occupations. Similarly, the “No Tax on Overtime” provision lets you deduct the “half-time” portion of your overtime pay, up to $12,500.
By reducing the federal tax burden on your tips and overtime pay, the legislation aims to increase your take-home pay. This is a game-changer for anyone in industries like hospitality, retail, and healthcare. This move was a response to economic pressures faced by middle- and lower-income Americans, who often rely on tips and overtime as substantial components of their income.
The legislation includes other elements that also aim to support working-class Americans. This includes increased child tax credits and deductions for seniors. Despite this, some critics argue that exempting tips and overtime pay from taxation could lead to consequences like reduced employer contributions to Social Security and Medicare.
What the Changes Entail
If you’re an eligible worker, the “No Tax on Tips” and “No Tax on Overtime” provisions allow you to deduct a portion of your tip income and overtime pay from your taxable income until 2028. This includes:
- No Tax on Tips: Deducting up to $25,000 in qualified tip income annually. It applies to single filers earning up to $150,000 and joint filers earning up to $300,000, with phase-outs for higher incomes. This affects eligible workers, like waitstaff and bartenders, hairdressers and barbers, casino dealers and valet attendants, taxi and rideshare drivers, hotel housekeeping staff, as well as tour guides and personal service providers.
- No Tax on Overtime: You can deduct the “premium” portion of your overtime pay (i.e., the amount above your regular hourly rate) up to $12,500 for single filers and $25,000 for joint filers annually. Eligible workers include healthcare professionals (like nurses and medical technicians), manufacturing and warehouse employees, logistics and transportation workers, construction and maintenance staff, as well as public safety personnel (firefighters and police officers).
It’s important to note that these deductions apply only to federal income tax. You’ll still be responsible for payroll taxes, including Social Security and Medicare contributions, on both tip and overtime income.
Impact of Tips and Overtime Taxation on Workers
One of the main effects of these changes is that you’ll have more take-home pay. This is because your federal income tax liability is lower. For example, if you are a single filer earning $50,000 in regular wages and $15,000 in overtime pay, you could reduce your taxable income by $12,500, resulting in potential tax savings of approximately $1,750 (if you’re in a 22% tax bracket). This increased take-home pay can enhance your financial security and leaves you with more money for increased spending.
But on the downside, the changes to taxation of tips and overtime have raised concerns regarding equity and fairness. Some argue that middle-income taxpayers will receive the largest benefits from the overtime deduction. This means that there is a risk that exempting tips and overtime pay from taxation could undermine tax equity. It could mean that individuals with similar total income may be taxed differently based on how their compensation is structured.
Another factor to consider is the impact on your reported income. This may have implications for various financial assessments, like:
- Mortgage applications: Lenders may consider your adjusted gross income (AGI) when evaluating loan eligibility. A lower AGI due to these deductions could impact your borrowing capacity.
- Creditworthiness: Credit scoring models often incorporate your income levels. So your reduced reported income might influence your credit assessments, despite your actual earnings being higher.
- Benefits eligibility: Eligibility for certain benefits, like income-based assistance programs, may be determined based on your AGI. A lower AGI because of these deductions could affect your access to these programs.
As such, you’ll need to plan accordingly when applying for loans or benefits.
We can help!
Navigating the changing rules around tip and overtime taxation can be tricky, especially when those changes affect everything from your borrowing power to your eligibility for certain benefits. Thoughtful tax planning can help you make the most of your increased take-home pay while avoiding unexpected financial setbacks.
If you’d like personalized guidance on how these changes impact your overall tax strategy, our team can help you assess your situation and develop a plan that maximizes your financial advantage. Schedule a free Discovery Call today to discuss your tax planning and strategy options.
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This blog does not provide legal, accounting, tax, or other professional advice. We base articles on current or proposed tax rules at the time of writing and do not update older posts for tax rule changes. We expressly disclaim all liability regarding actions taken or not taken based on the contents of this blog as well as the use or interpretation of this information. Information provided on this website is not all-inclusive and such information should not be relied upon as being all-inclusive.