Big news for hourly and tipped workers: starting in 2025, a new federal tax provision will allow qualifying employees to deduct portions of their overtime and tip income, potentially lowering their tax bills and making hospitality and service jobs more appealing.

Here’s a breakdown of what this means and how it could impact both workers and employers.

What’s Changing?

A new tax rule is giving a break to workers in jobs where tips and overtime are common—think servers, bartenders, hotel staff, and others in the hospitality and service industries. For tax years 2025 through 2028, eligible workers will be able to deduct a portion of their tip and overtime earnings from their federal income taxes.

Who’s Eligible?

• Income Limits:
  • Individuals earning $150,000 or less
  • Couples earning $300,000 or less
    (These thresholds will be adjusted for inflation in future years)
• Tip Income Requirements:
  • You must work in a role where receiving tips is customary—such as restaurant servers, bartenders, hotel bell staff, hairstylists, and similar jobs.
  • Only cash tips (including charged tips and those received through tip pooling) that are reported to employers for payroll tax purposes will qualify.
  • The maximum deduction for tip income is $25,000 per year.
• Overtime Pay Requirements:
  • Overtime income must meet the Fair Labor Standards Act (FLSA) definition—payment for hours worked over 40 in a week at a premium rate.
  • Only the premium portion of overtime pay (the amount above the standard hourly rate) is deductible.
  • The maximum deduction for overtime income is $12,500 per year, or $25,000 for joint filers.
  • Different overtime rules may apply under state law or collective bargaining agreements.

Note: The U.S. Treasury Department is expected to release a finalized list of eligible tipped occupations by October 2, 2025.

Why It Matters

This change is designed to help working-class employees, especially those in hospitality, keep more of what they earn. With labor shortages continuing across service industries, the policy could make these jobs more financially attractive and support recruitment and retention efforts.

What Employers Need to Do

Employers, especially in industries with tipped and hourly staff, should start preparing now:

• Payroll Adjustments: Update payroll systems to track and report tip and overtime income separately on W-2 forms.
• Training for HR and Payroll Teams:  Ensure staff understand how to categorize and report income correctly under the new rules.
• Communication with Employees:  Proactively inform workers about how to report eligible earnings and claim deductions when filing taxes. While the new deductions offer potential benefits for workers, they could also bring added administrative complexity for employers.

Final Thoughts

This tax provision is set to expire after the 2028 tax year, unless extended by Congress. For now, it’s a welcome development for workers who rely on tips and overtime—and a reminder for employers to stay ahead of the curve on compliance and communication.

 Stay tuned for more guidance from the Treasury Department later this year.