No tax on tips and overtime: What workers should know and who stands to see their taxes shrink

There are plenty of provisions in the massive tax bill known as the One Big Beautiful Bill Act that lawmakers are hotly contesting as Republicans rush to finalize the bill by their self-imposed July 4 deadline. But one tax law change that — until recently — seemed to have broad, bipartisan support is the proposal to eradicate taxes on tips.

The problem is, that provision — at least, as it’s been proposed both in the huge tax bill as well as in a standalone act that quickly passed the Senate with bipartisan support — wouldn’t help all that many workers.

And, truth be told, even that provision isn’t a slam dunk, as some Republicans have said it’s a pricey outlay with little prospect of sparking the economic growth they like to see from tax cuts.

Also part of the major tax bill is a proposal to remove taxes on overtime pay, although the House and Senate aren’t currently in sync on whether the tax break should be capped or not.

Here’s how the Senate bill compares to the House bill on each of these two provisions.

No taxes on tips and overtime: House vs. Senate bills

No tax on tips

No tax on overtime pay

What Trump’s ‘no tax on tips’ could mean for you

Under current law, a worker must pay federal income tax and payroll taxes on tip income, just as they do on regular wages. Employees are required to report monthly tips exceeding $20 to their employers, who must then withhold income and FICA taxes and report the amount to the IRS.

However, that could change if the big, beautiful bill becomes law. The Senate’s current version would create a new deduction for qualified tip income, eliminating federal income taxes on up to $25,000 in tips for workers for tax years 2025 through 2028. The tax break would start to phase out for taxpayers with modified adjusted gross income (MAGI) of $150,000 ($300,000 if married filing jointly) — the value of the deduction would drop by $100 for every $1,000 of income above that amount.

The House’s version doesn’t cap the dollar value of the tax break, but it would limit the tax break to taxpayers with MAGI of $160,000 or less. (Neither proposal affects payroll, or FICA, taxes.)

“​​An estimated four million individuals receive tip income. So those people could see a significant tax benefit,” says Mark Luscombe, principal tax analyst with Wolters Kluwer Tax & Accounting. “The [proposed] deductions for tips are available to non-itemizers, so they can be claimed even if the taxpayer claims the standard deduction.”

Workers would still need to report tip income and pay payroll taxes. While federal income tax would be withheld from paychecks, those amounts would be refunded when filing their income tax return.

The tax break wouldn’t apply only to employees. Some independent contractors and business owners could also qualify, provided their business gross receipts exceed business deductions, losses and costs, including the cost of goods sold.

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Who stands to benefit the most?

While this provision could eliminate taxes on tip income for millions of Americans, only a fraction of taxpayers may see a meaningful benefit. A study by the nonpartisan Tax Policy Center found that households earning $33,000 or less wouldn’t benefit much, as they typically owe little to no federal income tax. For all of these households (including those who don’t earn tip income), after-tax income would rise by just $10 a year on average.

Fully 40 percent of U.S. households that report tip income would not see any tax break from the proposal, according to the Tax Policy Center report.

That means 60 percent of households that report having tip income would benefit (that translates to about 2 percent of all U.S. households enjoying this tax break), and their tax bills would drop by an average of $1,800 a year, according to the report.

An average of $1,800 a year is not nothing. But that reward wouldn’t go to the lowest-earning households. Of those households making less than $33,000 a year, just 1.4 percent of households would benefit, and for those households, their after-tax income would rise by $450 a year on average.

Learn more: New ‘bonus’ tax deduction up to $6,000 could be on the way for those age 65 or older

Working overtime could soon bring a hefty tax cut

Employees who earn overtime may get a break on their federal taxes if the big bill becomes law. Under current law, employees must receive overtime pay — at least time and a half — for any hours worked beyond 40 in a workweek.

“There has been a trend toward less use of overtime pay; however, under the Biden administration, the salary threshold for employees eligible for overtime pay was significantly raised, currently at $58,656 and adjusted for inflation every three years,” Luscombe says. “The House bill will require clear reporting of overtime pay by the employer to support the claimed deduction.”

The proposed overtime tax break would function similarly to the tip income deduction. Overtime wages would still be subject to withholding, but workers could deduct federal income taxes paid on those wages when filing their returns, even if they don’t itemize. The deduction would apply to tax years 2025 through 2028.

The White House estimates that the average overtime worker would receive a tax cut of between $1,400 and $1,750 annually. But experts argue that the tax benefits wouldn’t benefit those who earn lower levels of income.

Effect on federal revenues

While some experts say workers who earn overtime and tip income would pay less taxes if the big bill becomes law, others warn the measure could increase the federal deficit and result in a significant loss of revenue.

The Joint Committee on Taxation estimates that the tip provision would reduce federal revenues by $40 billion from fiscal years 2025 to 2034, with most of the impact concentrated between 2026 to 2029, when the deduction would be in effect. The Congressional Budget Office estimates exempting overtime pay would cost $124 billion through 2028.

Some analysts also warn that eliminating taxes on overtime pay could disrupt the labor market. The Tax Foundation, a nonprofit tax policy group, said removing income taxes on overtime could “distort” the labor market by encouraging more workers to take overtime shifts, potentially making hourly roles more attractive than salaried positions that are exempt from overtime rules.

“Although the bill tries to restrict businesses not currently relying on tip income and overtime pay from seeking to take advantage of these proposed changes, it is still possible that there could be shifts toward tip income and more overtime pay to try to take advantage of the deductions,” Luscombe says.

Learn more: These 9 states have no income tax — that doesn’t always mean you’ll save money