Do you earn tips or work extra hours for overtime pay? A new federal tax law gives workers like servers, bartenders, hairstylists, delivery drivers, warehouse employees, and many others a chance to keep more of what they earn, especially from tips and overtime pay. Here’s what you need to know.

A New Tax Break for Working People

On July 4, 2025, a new law took effect, allowing many workers to avoid paying federal income tax on a portion of their tips and overtime pay. This could result in a bigger refund at tax time or less money withheld from your paycheck later.

How the Tax Break Works 

Tip Income Deduction

If you work in a job where tips are a regular part of your pay, you may now deduct up to $25,000 of that tip income from your taxable income. That means if you earned a total income of $40,000 and $15,000 of it came from tips, the IRS will only tax you on $25,000, at least for federal income tax purposes.

Overtime Deduction

For overtime work (meaning more than 40 hours a week), you can now deduct up to $12,500 of your overtime earnings from your federal taxable income. If your filing status is married filing jointly, that amount doubles to $25,000. However, this only applies to the half-time above your regular rate of pay. Taking on extra shifts or working late to make ends meet will mean you don’t get taxed on all your overtime wages. This rule applies to a specific group of workers as defined under the new law; your employer can not change your salary to hourly and have this new rule apply.

What’s the Catch?

There are a few things to keep in mind:

• It only applies to federal income tax. You will still pay Social Security, Medicare, and possibly state or city taxes on that income.
• Not everyone qualifies. If you earn more than $150,000 a year ($300,000 for joint filers), the benefit will gradually go away. Once you hit $160,000 or more, you can’t use the deduction at all.
• Only real tips count. Often seen at hotels or banquet halls, if your employer adds a mandatory service charge to bills, that doesn’t count as a tip and isn’t eligible for this break.
• Overtime must be properly tracked. You’ll need to know how much of your pay comes from overtime. This means if you are paid time and a half for your overtime rate, only the half part above your regular rate is excluded from taxes. W-2 forms are not being revised for 2025 reporting; employers must notify employees of the amount of overtime pay eligible for this deduction.  The 2026 W-2 forms will have a box where the data will be included.

When Does This Start?

The law applies to income earned starting on January 1, 2025. Therefore, when you file your taxes next spring for the 2025 tax year, this will be available to claim. Unless Congress extends this deduction, it is scheduled to last until the end of 2028.

What You Should Do Now

Here’s what we recommend:

• Keep records. Save your pay stubs or some other record with tip totals and hours worked. The more detail you have, the better.
• Talk to your employer. They’ll need to report your tip and overtime pay correctly on your W-2 (or 1099 if you’re an independent contractor).
• Don’t change your withholding just yet. The IRS hasn’t updated paycheck withholding tables yet, so it’s best to wait until they do later this year.
• Plan for tax season. If you use a tax preparer, make sure they know how much of your income comes from tips or overtime. If you prepare your taxes, the IRS has created a new form you will need to include with your tax return.

Contact Us Today

Understanding how these new tips and overtime tax breaks apply to your situation can help you keep more of what you earn. Call us at 203-489-0612 to make sure you’re getting the full benefit.

Written by: Roisin McGuirk