What employers need to know about ‘no tax on tips’ and ‘no tax on overtime’

Sections 70201 and 70202 of the One Big Beautiful Bill Act (H.R.1) introduce new above-the-line deductions for employees: one for qualified tip income and another for qualified overtime pay. The tip deduction is capped at $25,000 annually, while the overtime deduction is capped at $12,500 ($25,000 for joint returns). Each is reduced by $100 for every $1,000 of modified adjusted gross income above $150,000 ($300,000 for joint returns). Employer and employee social security and Medicare taxes will still apply.

Key Takeaways for Employers

No Tax on Tips

• The bill only applies to “qualified tips,” or those amounts paid voluntarily without any consequence in the event of nonpayment, are not the subject of negotiation, and are determined by the payor.
• Applies only to “cash” tips. Gifts in lieu of cash would not fall under the deduction.
• The deduction only applies to those in occupations that customarily receive tips. The IRS will, within 90 days, release a list of qualifying occupations.

Employers should continue to withhold tax on and report employee tips. When reporting on the information return (such as Form W-2), the Act requires a separate accounting of the amounts reasonably designated as cash tips and the occupation of the employee. Further IRS guidance is expected in the weeks ahead.

No Tax on Overtime

• The bill only applies to “qualified overtime” or that compensation paid under section 7 of the Fair Labor Standards Act (FLSA) that exceeds the regular rate at which such individual is employed.
• The overtime deduction only includes those FLSA requirements.
• An individual cannot claim that the qualified tips noted above are qualified overtime wages.

Employers should continue to withhold tax on and report overtime wages. When reporting on the information return (such as the Form W-2), the bill requires that it includes a separate accounting of the amounts reasonably designated as qualified overtime compensation. Further guidance is expected from the IRS in the weeks ahead.

We recommend that employers work with their attorney before making any changes to individuals’ employment status to ensure state and federal labor laws are met.

The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.