No tax on tips and overtime may have a significant impact on both your employees and your record-keeping. Final guidance is still forthcoming, but here are a few notes.
What Is the No Tax on Tips Ruling?
Until the close of 2028, individuals who receive qualified cash tips in occupations where tipping is customary may now be eligible for a deduction up to $25,000 per year (with that same amount being excluded from QBI to eliminate double tax benefits). A surprisingly broad list of nearly 70 occupations is currently included in the no tax on tips proposed regulations, including those in the beauty services, plumbing, delivery, personal wellness, and other areas.
Comments on the proposed regulations are due October 23, 2025. An income phaseout of $150,000 ($300,000 for joint taxpayers) applies. And another note: Self-employed individuals in a specified service trade or business under Section 199A are not eligible. Employees whose employer is in a specified service trade or business also are not eligible, the IRS states. More about the guidance and the definition of qualified tips under the proposed regulation can be found here.
Who Qualifies for No Tax on Overtime?
Also until the close of 2028, individuals who receive qualified overtime compensation may deduct the pay that exceeds their regular rate of pay required by the Fair Labor Standards Act (FLSA), with a maximum annual deduction of $12,500 ($25,000 for joint filers) for the “premium” portion of the overtime pay. The same income phaseout of $150,000 ($300,000 for joint taxpayers) applies, and married taxpayers must file jointly to claim the deduction.
While the change for tips has generated much more buzz, the overtime deduction is expected to affect 9% of households (versus just 3% of households that will benefit from no tax on tips).
Why Should Employers Improve Record-Keeping?
Employer payroll taxes remain, but business owners must begin tracking and reporting overtime premium pay and tips separately in payroll and W-2 forms. This will help employees keep track of their tips and overtime in order to report them separately on an expected new, two-page federal income tax form Schedule 1-A. It may mean updating software and procedures to ensure accurate accounting for each type of income, and keeping clear records to avoid IRS complications down the road.
Keep an eye on further clarifications of these two provisions as the 2025 tax season draws closer. The IRS intends to use artificial intelligence (AI) to improve audits, so small- and medium-sized businesses should stay proactive, well-documented, and responsive.
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