OBBBA Tip and Overtime Pay Deductions: What CPAs Need to Know for 2025–2028

Q: What the Overtime Premium Pay Deduction Covers

The qualified overtime pay deduction applies to the premium portion of overtime compensation. This is the differential paid above the employee's regular hourly rate for hours worked in excess of 40 per week under the Fair Labor Standards Act (FLSA) — commonly the "time-and-a-half" component. Example: An employee earning $20/hour works 50 hours in a week. Regular pay is $20 × 50 = $1,000. The overtime premium is $10/hour × 10 hours = $100. Only the $100 premium is deductible — not the full $1,000 wage. The deduction caps and phase-outs are: | Filing Status | Maximum Deduction | Phase-out Begins (MAGI) | |---|---|---| | Single / Head of Household / MFS | $12,500 | $150,000 | | Married Filing Jointly | $25,000 | $300,000 | The deduction phases out at $1 for every $1 of MAGI above the threshold, similar to the tip deduction. FLSA requirements apply: To claim the overtime deduction, the overtime must have been paid under an arrangement that complies with the FLSA — meaning a covered employee, a covered employer, and hours documented in excess of 40 per workweek. Exempt employees (executives, professionals, administrative employees paid on salary above the FLSA exempt threshold) generally do not receive FLSA overtime and cannot claim this deduction. Double-exempt seasonal workers and agricultural workers face similar restrictions. Employer reporting: The IRS is expected to require employers to separately report qualifying overtime premium pay on Form W-2. CPAs should advise employer clients in payroll-intensive industries (manufacturing, healthcare, logistics, hospitality) to confirm their payroll systems will track and report premium pay separately from regular wages before W-2 generation for tax year 2025.

Q: The SE Tax Problem: Why These Deductions Don't Help Self-Employed Clients

Both deductions are limited to employees receiving W-2 compensation. Self-employed individuals — sole proprietors, single-member LLC owners, independent contractors on Schedule C — cannot claim either deduction, regardless of whether they work in a qualifying occupation or work more than 40 hours per week. This creates a common misconception CPAs should preemptively address with clients: - A self-employed food truck operator cannot deduct tips they receive from customers. - A freelance consultant who bills overtime hours cannot deduct any "premium" amount. - A gig economy worker driving for a rideshare platform and reporting income on Schedule C has no access to these deductions. For employed clients who do qualify, the deductions reduce federal income tax by reducing AGI — but they do not reduce the employee's FICA withholding, which is separately computed on gross wages. A tipped restaurant employee earning $35,000 in tips can deduct up to $25,000 of those tips from AGI, potentially eliminating a significant income tax liability — but their employer still withholds Social Security and Medicare tax on those tips under IRC §3101. For clients with large tip income, this distinction is the single most important planning communication CPAs should deliver upfront. For clients who want to reduce self-employment tax on their overall business income, the primary tool remains entity structuring — specifically the S-Corporation election and reasonable salary strategy.

Q: Phase-Out Calculations: Working Through the Math

Example 1 — Tip deduction phase-out (single filer): A bartender employed by a restaurant has $22,000 in reported W-2 tip income and $135,000 in MAGI from all sources. MAGI is below the $150,000 threshold, so the full $22,000 tip deduction is available. Example 2 — Tip deduction partial phase-out (single filer): Same bartender, but $175,000 in MAGI. Phase-out begins at $150,000, so $25,000 of excess MAGI. The deduction is reduced by $25,000 (the phase-out is dollar-for-dollar). Maximum deduction was $22,000 (actual tips, below $25,000 cap). After phase-out: $22,000 − $25,000 = $0. The deduction is fully eliminated at MAGI $25,000 above the threshold for any filer claiming the full $25,000 cap. Example 3 — Overtime deduction (MFJ): A nurse employed by a hospital earns $18,000 in FLSA overtime premium pay during the year. Household MAGI is $260,000. MAGI is below the $300,000 MFJ threshold, so the full $18,000 overtime deduction is available (well under the $25,000 MFJ cap). Example 4 — Overtime deduction near phase-out (MFJ): Same nurse household, but MAGI is $315,000. Excess over $300,000 = $15,000. Deduction reduced from $18,000 to $3,000.

Q: Effective Date and Sunset

Both deductions apply to tax years beginning after December 31, 2024 and before January 1, 2029 — meaning they are available for 2025, 2026, 2027, and 2028 returns only. Absent further legislation, these provisions expire after tax year 2028. CPAs should flag the sunset date in any multi-year projection for clients who qualify — particularly for wage structuring and employer compensation design decisions that may be made for the 2026 and 2027 years. As part of year-end planning for clients in qualifying industries, the tip and overtime deductions should be included in year-end income projections starting in October each year.

The One Big Beautiful Bill Act (OBBBA) introduced two new above-the-line deductions for individual taxpayers: a deduction for qualified tip income and a deduction for qualified overtime premium pay. Both are effective for tax years 2025 through 2028 and available to employees who receive this income from covered occupations. Neither deduction reduces self-employment tax — a critical distinction that affects how CPAs advise sole proprietors and independent contractors who are not W-2 employees. Understanding the rules, the occupational limitations, and the interaction with other planning levers is essential before filing season for 2025 returns.

What the Tip Deduction Covers

The qualified tip income deduction allows eligible employees to deduct tip income from their federal adjusted gross income. The deduction maximum is $25,000 per year, regardless of filing status. It phases out dollar-for-dollar when MAGI exceeds:

$150,000 for single filers, heads of household, and married filing separately
$300,000 for married filing jointly

Who qualifies: The deduction applies to employees who work in an occupation that customarily and regularly received tip income before December 31, 2024. IRS is expected to publish a list of qualifying occupations, but the statutory framing points to the traditional service sectors: food and beverage service, hospitality, barbering and cosmetology, valet parking, and similar client-facing roles where gratuities are a long-standing and expected part of compensation. The IRS has not yet released the final qualifying occupation list as of early 2026; CPAs should monitor IRS Notice publications at irs.gov/newsroom for updated guidance.

What does not qualify:

Tips received by independent contractors or self-employed individuals — the deduction is employee-only
Tips received in newly tipped occupations established after December 31, 2024
Tips received by employees whose primary occupation is not on the qualifying list, even if they occasionally receive gratuities
Cash tips not reported to the employer (though all tips remain taxable income regardless of whether this deduction applies)

Recordkeeping requirement: Employees must report all tips to their employer per IRC §6053(a), and employers must include reported tips on Form W-2, Box 7. Clients claiming the deduction must be able to substantiate the tip amount through W-2 reporting or employer tip-pooling records. Encouraging clients to report tips accurately throughout the year — not just at filing — is the practice management action CPAs should take now.

What the Overtime Premium Pay Deduction Covers

The qualified overtime pay deduction applies to the premium portion of overtime compensation. This is the differential paid above the employee's regular hourly rate for hours worked in excess of 40 per week under the Fair Labor Standards Act (FLSA) — commonly the "time-and-a-half" component.

Example: An employee earning $20/hour works 50 hours in a week. Regular pay is $20 × 50 = $1,000. The overtime premium is $10/hour × 10 hours = $100. Only the $100 premium is deductible — not the full $1,000 wage.

The deduction caps and phase-outs are:

Filing Status	Maximum Deduction	Phase-out Begins (MAGI)
Single / Head of Household / MFS	$12,500	$150,000
Married Filing Jointly	$25,000	$300,000

The deduction phases out at $1 for every $1 of MAGI above the threshold, similar to the tip deduction.

FLSA requirements apply: To claim the overtime deduction, the overtime must have been paid under an arrangement that complies with the FLSA — meaning a covered employee, a covered employer, and hours documented in excess of 40 per workweek. Exempt employees (executives, professionals, administrative employees paid on salary above the FLSA exempt threshold) generally do not receive FLSA overtime and cannot claim this deduction. Double-exempt seasonal workers and agricultural workers face similar restrictions.

Employer reporting: The IRS is expected to require employers to separately report qualifying overtime premium pay on Form W-2. CPAs should advise employer clients in payroll-intensive industries (manufacturing, healthcare, logistics, hospitality) to confirm their payroll systems will track and report premium pay separately from regular wages before W-2 generation for tax year 2025.

The SE Tax Problem: Why These Deductions Don't Help Self-Employed Clients

Both deductions are limited to employees receiving W-2 compensation. Self-employed individuals — sole proprietors, single-member LLC owners, independent contractors on Schedule C — cannot claim either deduction, regardless of whether they work in a qualifying occupation or work more than 40 hours per week.

This creates a common misconception CPAs should preemptively address with clients:

A self-employed food truck operator cannot deduct tips they receive from customers.
A freelance consultant who bills overtime hours cannot deduct any "premium" amount.
A gig economy worker driving for a rideshare platform and reporting income on Schedule C has no access to these deductions.

For employed clients who do qualify, the deductions reduce federal income tax by reducing AGI — but they do not reduce the employee's FICA withholding, which is separately computed on gross wages. A tipped restaurant employee earning $35,000 in tips can deduct up to $25,000 of those tips from AGI, potentially eliminating a significant income tax liability — but their employer still withholds Social Security and Medicare tax on those tips under IRC §3101. For clients with large tip income, this distinction is the single most important planning communication CPAs should deliver upfront.

For clients who want to reduce self-employment tax on their overall business income, the primary tool remains entity structuring — specifically the S-Corporation election and reasonable salary strategy.

Interaction with the QBI Deduction

For S-Corp owner-employees who also receive tips in qualifying occupations, the interaction is nuanced:

The QBI deduction under Section 199A applies to the S-Corp's qualified business income allocated to the shareholder — not to W-2 wages received from the corporation.
Tip income reported on the employee's W-2 is not QBI — it is W-2 compensation, which is excluded from QBI under IRC §199A(c)(4)(A).
The tip deduction and the QBI deduction are additive for AGI purposes — a qualifying employee-shareholder can claim both without conflict.

CPAs working with restaurant or hospitality business owners who both own their S-Corp and work as tipped employees of the corporation should model both deductions in their projection software. The OBBBA also raised the QBI deduction rate to 23% and made it permanent, so the combined effect of both deductions can be significant for this client profile.

Phase-Out Calculations: Working Through the Math

Example 1 — Tip deduction phase-out (single filer):

A bartender employed by a restaurant has $22,000 in reported W-2 tip income and $135,000 in MAGI from all sources. MAGI is below the $150,000 threshold, so the full $22,000 tip deduction is available.

Example 2 — Tip deduction partial phase-out (single filer):

Same bartender, but $175,000 in MAGI. Phase-out begins at $150,000, so $25,000 of excess MAGI. The deduction is reduced by $25,000 (the phase-out is dollar-for-dollar). Maximum deduction was $22,000 (actual tips, below $25,000 cap). After phase-out: $22,000 − $25,000 = $0. The deduction is fully eliminated at MAGI $25,000 above the threshold for any filer claiming the full $25,000 cap.

Example 3 — Overtime deduction (MFJ):

A nurse employed by a hospital earns $18,000 in FLSA overtime premium pay during the year. Household MAGI is $260,000. MAGI is below the $300,000 MFJ threshold, so the full $18,000 overtime deduction is available (well under the $25,000 MFJ cap).

Example 4 — Overtime deduction near phase-out (MFJ):

Same nurse household, but MAGI is $315,000. Excess over $300,000 = $15,000. Deduction reduced from $18,000 to $3,000.

Effective Date and Sunset

Both deductions apply to tax years beginning after December 31, 2024 and before January 1, 2029 — meaning they are available for 2025, 2026, 2027, and 2028 returns only. Absent further legislation, these provisions expire after tax year 2028. CPAs should flag the sunset date in any multi-year projection for clients who qualify — particularly for wage structuring and employer compensation design decisions that may be made for the 2026 and 2027 years.

As part of year-end planning for clients in qualifying industries, the tip and overtime deductions should be included in year-end income projections starting in October each year.

What CPAs Should Be Doing Now

Client communication: Identify clients who work in food service, hospitality, personal care, and other traditionally tipped industries. Send a targeted advisory explaining the tip deduction, the MAGI threshold, and the W-2 reporting requirement. Proactively asking clients about tip reporting habits now prevents missed deductions at filing.

Employer clients: For business owner clients with hourly or shift workforces — restaurants, healthcare staffing firms, logistics companies, construction contractors — confirm that payroll vendors will separately track and report FLSA overtime premium pay on W-2s. This is a payroll software configuration question that must be addressed before year-end payroll runs. These same service-sector employers are also strong candidates for the OBBBA expansion of the §45F employer childcare tax credit, which was raised to 40% of qualifying expenditures with a $500,000 annual cap — a separate OBBBA benefit worth stacking into the same planning engagement for employers who provide or contract with childcare facilities for their workforce. For clients in manufacturing, software, or technology — where the OBBBA also restored immediate expensing of domestic R&D costs under new IRC §174A — there is a separate and time-sensitive retroactive election available for 2022–2024. Small businesses (≤$31M gross receipts) can amend prior returns to recover three years of over-payment, but the 2022 SoL window closes April 15, 2026 for clients who filed without extension. See the Section 174A R&D Expensing Guide for the election procedure.

Projection software: Update planning models to include both deductions for eligible clients. Phase-out thresholds interact with other MAGI-sensitive calculations (IRMAA, ACA premium subsidies, student loan deductibility), so model the full AGI impact before advising on income acceleration or deferral strategies. The OBBBA also created a separate car loan interest deduction (up to $10,000/year) for new American-assembled vehicles, reported on the same Schedule 1A — add this to planning models for clients who financed a qualifying vehicle in 2025–2028.

Gig economy clients: Clients earning platform income on Schedule C — even from platforms in traditionally tipped industries — should be clearly advised that neither deduction applies to self-employment income. For these clients, the more effective tax reduction tool is proper expense documentation on Schedule C and SE tax structuring.

Monitor IRS guidance: The qualifying occupation list for the tip deduction has not been finalized. Advise clients to preserve all tip reporting records and W-2 documentation now, even before the official list is published, so they are positioned to claim the deduction once guidance is confirmed.

FAQ

What types of workers can claim the OBBBA tip deduction?

Employees in occupations that customarily and regularly received tip income before December 31, 2024. The IRS will publish the qualifying occupation list; expected industries include food service, beverage service, hospitality, personal care (barbers, cosmetologists), and valet. The deduction is not available to self-employed individuals, independent contractors, or workers in occupations newly designated as tipped after 2024.

Does the tip deduction reduce Social Security and Medicare taxes?

No. The deduction reduces federal adjusted gross income and federal income tax only. FICA taxes — both the employee's 7.65% share and the employer's matching 7.65% — are computed on gross wages including tip income. The deduction does not affect state income taxes in most states, though CPAs should verify state conformity.

Is there a minimum amount of tip income required to claim the deduction?

No minimum is specified in the OBBBA. Any amount of qualifying tip income is potentially deductible up to the $25,000 cap, subject to the MAGI phase-out.

Can an S-Corp owner-employee who works as a tipped employee claim the tip deduction?

Yes, if they work in a qualifying occupation and receive tips as a W-2 employee of their corporation. The tips must be reported on W-2, Box 7. The S-Corp itself does not benefit — the deduction is an individual above-the-line adjustment on the owner's Form 1040.

What counts as the "overtime premium" for the overtime deduction?

Only the differential amount above the regular rate of pay for overtime hours — the "half" in "time and a half." The regular rate portion of overtime hours is not deductible. The overtime must be paid under FLSA-compliant arrangements. Salaried exempt employees who receive discretionary overtime bonuses generally do not qualify.

When do these deductions expire?

Both the tip deduction and the overtime deduction sunset after tax year 2028. Absent further legislation, they will not be available for 2029 returns.

How do these deductions interact with the SALT deduction?

Both reduce federal AGI, which can affect the SALT deduction only if the taxpayer is in phase-out territory for the SALT cap (MAGI above $500,000 under OBBBA). For most tip and overtime earners, MAGI will be well below the SALT phase-out threshold, so there is no interaction.

Are tips that were not reported to an employer deductible?

No. To claim the deduction, tips must have been reported to the employer and reflected on Form W-2. Unreported cash tips remain taxable as income under IRC §61 and do not qualify for the deduction.

Arvori helps CPA firms stay current on emerging tax provisions and manage client communications around new legislation. Learn how the platform supports tax planning workflows at arvori.app.

OBBBA Tip and Overtime Pay Deductions: CPA Guide for 2025–2028