How the federal tips and overtime deductions work, who qualifies, what counts as qualified overtime, and the records and reporting employers should prepare.
The phrase “no tax on tips” and “no tax on overtime” can sound as if employers should stop withholding on those wages. That is not how the law works. The new rules are deductions that eligible workers claim on their individual federal income tax returns. Payroll still runs much as before: tips and overtime are still wages, federal income tax withholding still applies under the normal rules, and Social Security and Medicare (FICA) taxes still apply.
EZTime labor rule alerts flag overtime and missed rest periods before payroll.
What changes for employers is the paperwork. To claim the deductions, employees need to know how much of their pay was qualified tips and how much was qualified overtime premium. That information has to come from somewhere, and the most reliable source is the employer’s payroll and time records. Employers who already keep clean records of hours, overtime and tips will find this much easier than those who rely on rough estimates.
Employees will also ask questions. Managers in restaurants, hotels, salons, warehouses and other hourly workplaces should understand the basics well enough to answer simply and point people to the IRS for tax advice.
For tax years 2025 through 2028, eligible individuals can deduct up to $25,000 a year of qualified tips. The deduction is available whether or not the person itemizes. It begins to phase out when modified adjusted gross income exceeds $150,000 ($300,000 for joint filers), shrinking by $100 for each $1,000 of income above the threshold.
Key conditions include:
Tips that employees never report are not only a compliance problem for the employer; they also cannot support the deduction. That gives employees a new reason to report tips accurately, and employers a good opportunity to tighten their tip reporting process.
For the same years, eligible individuals can deduct up to $12,500 a year ($25,000 on a joint return) of qualified overtime compensation, with the same income phase-out thresholds as the tips deduction. Again, the deduction is claimed on the individual’s return and does not change payroll taxes.
The most important detail is what “qualified overtime compensation” means. It is not the whole overtime paycheck. It is the premium portion of overtime pay that is required under section 7 of the Fair Labor Standards Act. When an employee earns time and a half, the “time” is regular pay and only the “half” is the premium.
Maria is a non-exempt warehouse associate paid $20 an hour. In one week she works 46 hours. Under the FLSA overtime rules, she is owed 40 hours at $20 plus 6 hours at $30.
| Item | Calculation | Amount |
|---|---|---|
| Regular pay for 40 hours | 40 × $20 | $800 |
| Overtime pay for 6 hours | 6 × $30 | $180 |
| Total pay | $800 + $180 | $980 |
| Of which overtime premium (the “half”) | 6 × $10 | $60 |
Only the $60 premium counts toward the overtime deduction for that week. If Maria’s employer also paid a nondiscretionary bonus, her regular rate would rise, and so would the premium. Getting the regular rate right now matters twice: once for wage and hour compliance and again for the employee’s tax deduction.
Because the deduction follows the FLSA requirement, some overtime-style pay may fall outside it. Examples employers should flag for their payroll provider or tax adviser include:
The IRS has issued guidance on these points and may issue more. Treat this list as a prompt to check, not as a final rule.
The law requires employers to report qualified tips and qualified overtime compensation separately to employees and the IRS, and to report the occupation of tipped employees. The IRS announced that the 2025 Form W-2 would not change and offered transition relief for 2025, encouraging employers to give employees the information in another way, for example through an online portal or a separate statement. Updated forms and codes are expected for later years. Because this area is still changing, confirm the current requirements on IRS.gov or with your payroll provider before each year-end.
Every number in this process starts with hours worked. If clock-ins are missing, breaks are not recorded or managers edit timecards without a trail, the overtime premium on the W-2 or year-end statement will be wrong, and so will overtime pay. Clean time data, with a clear timekeeping policy and an approval workflow, makes the new reporting a by-product of normal payroll instead of a year-end scramble.
EZTime records clock-ins and breaks from the mobile app or a kiosk, calculates daily and weekly overtime based on the rules you set and separates regular and overtime hours in payroll exports. For restaurants and other tipped workplaces, the tip pooling feature helps you record and distribute tips per shift. Reports by employee and pay period give your payroll provider the figures it needs.
No. Employers continue to withhold federal income tax and FICA as usual. Employees claim the deductions on their own returns.
Up to $12,500 a year, or $25,000 on a joint return, of the FLSA-required overtime premium, subject to an income phase-out.
No. Only the premium portion above the regular rate, usually the “half” in time and a half, counts as qualified overtime compensation.
Generally no. Qualified tips must be paid voluntarily by the customer.
As enacted, they apply to tax years 2025 through 2028.
Overtime paid only because of state law, a contract or company policy may not qualify, because the deduction follows the FLSA requirement. Check current IRS guidance.
EZTime’s labor rule alerts warn about weekly hour limits, short rest between shifts, overtime thresholds and employees who forgot to clock out. See current plans and what each one includes on the pricing page.