The Tip and Overtime Deductions Cap at $25,000 and $12,500, and Both End After 2028

For the 2025 tax year (the return you file in 2026) through 2028, a worker in a listed tipped occupation can deduct up to $25,000 of reported tips from federal taxable income, and an hourly worker can deduct up to $12,500 of overtime premium pay, or $25,000 on a joint return. Section 70201 of the One Big Beautiful Bill Act wrote the tip deduction into the tax code as §224; §70202 wrote the overtime deduction as §225. Both are claimed on Schedule 1-A whether or not you itemize, and both phase out above $150,000 of income. The limits do the work: an occupation list, a half-time definition of overtime premium, a joint-filing rule for married workers, and a sunset after 2028.

What counts as a qualified tip

A qualified tip is voluntary. The IRS test, from Rev. Rul. 2012-18, asks whether the customer was free to pay nothing and free to set the amount, so an automatic 18% charge on a party of eight is a service charge, taxed as regular wages no matter what the receipt calls it. A tip added freely on top of a service charge still counts.

A qualified tip is also a reported tip. New §224 allows the deduction only for tips that reach a W-2, a 1099, or Form 4137, the form for reporting tips your employer never saw. Cash that goes unreported was taxable before this law and stays both taxable and undeductible now.

Two exclusions follow the business rather than the occupation. Tips received in the course of a specified service trade or business under §199A(d)(2) do not qualify, for employees of those businesses as well as for their owners. And a self-employed worker's deduction cannot exceed the net income of the business the tips came from.

The occupation list is final

Congress limited the deduction to occupations that customarily and regularly received tips on or before December 31, 2024, and left the list to Treasury. Proposed regulations came in September 2025; final regulations followed on April 10, 2026, naming more than 70 occupations, each with a three-digit Treasury Tipped Occupation Code, in eight categories that run from beverage and food service to transportation and delivery. The IRS's own summary spans "bartenders to water taxi operators," and the final round added visual artists, floral designers, and gas pump attendants. The list is the boundary: an occupation that is off it gets no deduction, however routinely its customers tip.

What $18,000 of tips saves at $65,000

Take a single bartender with $65,000 of 2025 W-2 wages, $18,000 of it reported tips. The $15,750 standard deduction leaves $49,250 of taxable income, and the 2025 single-filer 22% bracket starts at $48,475, so $775 of that income sits in the 22% band. Deducting the full $18,000 on Schedule 1-A empties the 22% slice first and takes the rest out of the 12% band:

The saving arrives without itemizing, because Schedule 1-A stacks on top of the standard deduction.

Overtime counts only the half above your base rate

The Fair Labor Standards Act requires covered workers to be paid at least one and a half times their regular rate for hours past 40 in a workweek. Section 225 reaches only the FLSA-required pay "in excess of the regular rate": the premium half. A $28-an-hour machinist's $42 overtime rate splits into $28 of ordinary wages and $14 of deductible premium.

Eight overtime hours a week for 50 weeks of 2025 pays that machinist $16,800 of total overtime, of which the premium is $5,600 (8 hours × $14 × 50 weeks). W-2 wages total $75,040; after the $15,750 standard deduction, taxable income is $59,290, and the whole deduction comes out of the 22% bracket, saving $1,232 on the 2025 return. Reaching the $12,500 cap at that wage takes 893 overtime hours, about 17 extra hours every week of the year.

Three groups sit outside the deduction because the FLSA never requires their premium:

• Exempt salaried employees under the 29 CFR part 541 tests (executive, administrative, professional, and the rest) have no FLSA overtime, however long their weeks run.
• Independent contractors are outside the FLSA altogether.
• Premium beyond the federal requirement does not count. State-law daily overtime, such as California's, and contractual double time qualify only to the extent §7 of the FLSA itself compels the pay.

One phase-out formula, two eligibility rules

Both deductions shrink by $100 for each $1,000 of modified adjusted gross income above $150,000, or above $300,000 on a joint return (§224(b)(2), §225(b)(2)). MAGI here is AGI plus excluded foreign or territory income, so unless you claim the foreign earned income exclusion or its equivalents, it equals AGI. A couple at $320,000 of MAGI is $20,000 over the line, and either deduction, whatever it would otherwise be, drops by $2,000. The caps set the endpoints; a worker with less than the full cap reaches zero sooner.

The tip cap does not double on a joint return; the overtime cap does. Two rules gate both deductions: the return must carry the worker's Social Security number, and a married worker must file jointly, so filing separately makes the deduction zero (§224(f), §225(e)). A worker with qualifying tips and qualifying overtime claims both, each under its own cap, and §225(c) keeps the two apart by excluding tips from qualified overtime.

What neither deduction touches

Payroll tax is unchanged. Every reported tip remains subject to Social Security and Medicare taxes, and overtime wages do too; the deduction reduces federal income tax only, and the W-2 still reports the full amounts.

AGI is unchanged. Schedule 1-A's total lands on Form 1040 line 13b, beside the standard deduction, after AGI is already settled, so anything computed from AGI, from IRA phase-outs to Medicare's income-related premium surcharges, is figured as though these deductions did not exist. Earlier versions of this article described them as above-the-line deductions that lower AGI; that was wrong, and the fix is logged at Corrections.

State income tax is a separate question, and the one state that ran the experiment itself has ended it. Alabama exempted hourly workers' overtime pay from its own income tax on January 1, 2024 under Act 2023-421, as amended by Act 2024-437, and let the exemption expire on June 30, 2025, four days before the federal version was signed. In the nine states with no tax on wage income, tips and overtime were never state-taxed to begin with. Elsewhere the answer turns on where the state return starts. A state that starts from federal AGI, as New York does under Tax Law §612(a), never sees a deduction that lands below the line on Form 1040 line 13b. A state that starts from federal taxable income inherits it automatically: Colorado's return does, and its legislature then added the overtime half back for tax years from 2026 while letting the tip deduction flow through.

The 2025 return works from pay stubs

No 2025 W-2 or 1099 separately reports qualified tips or overtime: as part of the law's phased rollout, the IRS left the 2025 forms unchanged. Notice 2025-69 supplies the bridge for the returns being filed in 2026. For tips, use box 7 of the W-2 (Social Security tips) or your monthly Form 4070 reports to your employer. For overtime, use pay stubs and year-end statements, and where a stub shows only the combined time-and-a-half amount, treat one-third of it as the premium. The machinist's arithmetic above is that rule in miniature: $5,600 is one-third of $16,800. Tax-year 2026 forms add the separate reporting, so next season's numbers come straight off the W-2.

The clock is the last constraint. Sections 224(h) and 225(g) allow no deduction for any taxable year beginning after December 31, 2028. That is four filing seasons, the returns filed in 2026 through 2029, unless Congress extends what it wrote.

This article is for informational purposes only and does not constitute tax advice. Consult a qualified tax professional for guidance specific to your situation.