Before the One Big Beautiful Bill Act (OBBBA), tip income and overtime income were fully taxable for federal income tax purposes. The new law changes that.

The One Big Beautiful Bill Act (OBBBA) is shaking up how certain types of income are taxed. From 2025 through 2028, small business owners and workers can take advantage of new tax deductions on tips and overtime pay. While the rules may feel a little complicated, the savings could be worth it. Let’s break it down.

1. Tip Income Deduction

First, let’s look at tips. Under the new law, you may be able to deduct up to $25,000 of qualified tip income each year. However, this benefit starts to phase out once your income goes above $150,000 (or $300,000 if you’re filing jointly with a spouse).

What makes this deduction interesting is that it doesn’t only apply to waitstaff or bartenders. The IRS has drafted a list of occupations where tips are considered “customary,” and it includes some surprising ones — such as plumbers, electricians, HVAC installers, digital content creators, and even home movers.

On the other hand, certain fields like healthcare, law, accounting, and financial services do not qualify. So, while this deduction is broad, it definitely has limits. The good news is that tips can count whether they are paid in cash, by card, or shared among workers, and you can claim the deduction even if you don’t itemize your tax return.

2. Overtime Income Deduction

Next, let’s talk about overtime pay. From 2025–2028, workers can deduct up to $12,500 of overtime income each year, or $25,000 if filing jointly. Just like with tips, the deduction phases out for higher-income earners at $150,000 for individuals or $300,000 for joint filers.

It’s important to note that “qualified overtime” only covers the extra half-pay you earn under federal law for working overtime hours (the “time-and-a-half” rule). This means that state-specific overtime rules or union contract overtime premiums don’t count toward the deduction. And, unlike tips, overtime pay and tip income cannot be combined.

3. Payroll and Tax Implications

At this point, you may be thinking these changes mean “no tax on tips” or “no tax on overtime.” However, that’s not quite true. These are deductions, not exclusions. In other words, payroll taxes still apply, and part of your income may still be taxed. On top of that, state and local taxes may treat tips and overtime differently, which could leave you with additional tax obligations.

For employers and payroll providers, the real challenge is reporting. If tip income and overtime income aren’t tracked and reported properly, employees could lose out on the deductions they deserve.

4. Reporting Rules

So how does reporting work? For tips, both employees and self-employed individuals can claim the deduction. Qualified tip income must appear on a W-2, 1099-NEC, or another IRS-approved form. Overtime income must be reported on a W-2 or other official statement.

Even though these new deductions are available starting in 2025, the IRS has announced that there will be no changes to tax forms or withholding tables until 2026. This decision was made to give small business owners, payroll firms, and tax professionals time to adjust.

5. What Small Business Owners Should Do Now

In the meantime, it’s smart to begin tracking qualified tip and overtime income immediately. The IRS has hinted that there will be transition relief for 2025, but once 2026 arrives, reporting rules will tighten. If you own a small business, setting up systems now can save you and your employees from headaches later.

✅ Takeaway for Small Business Owners:
These new tax bill deductions offer valuable savings opportunities on tip income and overtime pay. But they also add new reporting responsibilities. By staying proactive and keeping good records, you’ll be ready to help your team — and yourself — take advantage of these temporary but powerful tax breaks.

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