The One Big Beautiful Bill was signed into law on July 4, 2025. This new law includes two notable provisions that generally make tips and overtime pay exempt from federal income taxes. These changes are intended to boost take-home pay for many workers, particularly in service and blue-collar industries. On September 2, 2025, the Treasury Department and IRS issued a preliminary list of tipped occupations that will be eligible to claim tax deductions for tips. 

What Employers Should Know

No Tax on Overtime Pay

Effective for 2025 through 2028, employees who received “qualified overtime compensation” may deduct the pay that exceeds their regular rate of pay; that is, employees may deduct the “half” portion of the “time and one half” amount they receive as overtime pay. 

Also, qualified overtime compensation only includes pay that an employer is required to pay under the federal Fair Labor Standards Act—i.e., it does not include overtime premium pay that is not legally required, such as extra pay for working on a holiday or weekend (where hours worked do not exceed 40 in a workweek). This exemption applies to non-exempt employees. 

The maximum annual deduction is $12,500 for individual filers and $25,000 for joint filers. These annual caps are reduced by $100 for each $1,000 of income over $150,000 for single filers and $300,000 for joint filers. 

Employers are required to include the total amount of qualified overtime compensation paid on the IRS Form W-2. Qualified overtime pay remains subject to payroll taxes, such as social security and Medicare, and remains subject to unemployment taxes.

The IRS recently released draft versions of the 2026 Forms W-2, which include new reporting boxes for overtime and tip income. 

No Tax on Tips

Also effective from 2025 through 2028, employees (including self-employed individuals) who are engaged in occupations that are listed by the IRS as customarily and regularly receiving tips before January 1, 2025, may deduct “qualified tips.” A “preliminary” list of qualifying occupations was published on September 2, 2025, and includes 68 occupations across the following eight industries: Beverage and Food Service, Entertainment and Events, Hospitality and Guest Services, Home Services, Personal Services, Personal Appearance and Wellness, Recreation and Instruction, and Transportation and Delivery. The list can be found here. The IRS and Treasury Department will request public comments on the preliminary list before it is finalized. 

“Qualified tips” are voluntary cash or charged tips received from customers or through tip sharing. Service charges that are automatically assessed to customers do not count as qualified tips. 

The maximum annual deduction is $25,000, and the phase out of this deduction for high earners is the same as that which applies to the overtime deduction. Also, similar to the deduction for overtime pay, employers must track and report all “qualified tips” on the IRS Form W-2, and qualified tips remain such to payroll and unemployment taxes. 

Next Steps for Employers

Connecticut employers should understand that these deductions only apply to federal income tax. All wages remain fully taxable under Connecticut law. Employers should work closely with payroll vendors to ensure that qualified overtime compensation and qualified tips are property tracked and recorded. Employers should also continue to monitor additional guidance from the IRS.

For more information, please contact:

Nick Zaino
Partner
[email protected]
203.5784270

This information is for educational purposes only, to provide general information and a general understanding of the law. It does not constitute legal advice and does not establish any attorney-client relationship.