For those who are self-employed, deduction may not exceed the individual’s net income from the trade or business in which the tips were earned, according to the IRS.
The National Restaurant Association is among industry groups that have been strong backers of a “No Tax on Tips” provision.
“Eliminating taxes on tips would put cash back in the pocket of a significant number of workers in the restaurant and food service industry and could help restaurant operators recruit industry workforce,” Sean Kennedy, executive vice president of public affairs for the association, said.
While there is still much to be learned about how these changes will affect companies, Dayton Area Chamber of Commerce President Chris Kershner said business owners and managers already have their hands full when it comes to overseeing employees and operations.
“While Dayton area businesses have not received guidance yet from the U.S. Department of Treasury or the Internal Revenue Service on the new law, we are hopeful that it doesn’t create additional administration for the business community,” he said.
Individuals who receive qualified overtime compensation may also deduct the pay that exceeds their regular rate of pay, according to the bill’s “no tax on overtime” provision, which is also effective temporarily through 2028.
The maximum annual deduction for overtime pay is $12,500, or $25,000 for joint filers.
Deduction eligibility for both tips and overtime phases out for taxpayers with modified adjusted gross income of more than $150,000, or $300,000 for joint filers.
The average worker is expected to see a tax cut of between $1,400 and $1,750 per year, according to the White House Council of Economic Advisers.
Tax-free tips would reduce federal revenue by $31 billion between the 2026 and 2029 fiscal years, while tax-free overtime would reduce federal revenue by $90 billion during the same period, according to an analysis by the nonpartisan Joint Committee on Taxation.
“If you look at the data on tipped income, that would cover the majority of individuals earning tips in the United States,” Garrett Watson of the Tax Foundation, an organization that advocates for simplifying the tax code in pursuit of economic growth, told other media outlets. “So, it’s still pretty generous for most workers.”
If a worker makes more than $150,000 a year, though, their tipped income will start to be taxed.
“That helps to sort of carve out some of the very high earners who may be incentivized to recharacterize their income tips inappropriately,” Watson said.
What to know
Under the bill President Donald Trump signed into law on July 4, the U.S. Treasury Department must publish a list by Oct. 2 of occupations that qualify for tax-free tips. The department is also expected to publish guidance on how to report tips and overtime pay, as well as what documentation will be required.
Employers and other payors must file information returns with the IRS (or Social Security Administration) and furnish statements to taxpayers showing certain cash tips received and the occupation of the tip recipient.
The IRS will provide guidance regarding reasonable methods for employers to estimate the amount of qualified tips for 2025, given the retroactive effective date of Jan. 1.
Self-employed individuals in a Specified Service Trade or Business (SSTB) under section 199A are not eligible. Employees whose employer is in an SSTB also are not eligible.
The IRS defines an SSTB as any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners. This can include consulting, brokerage, law, or trading services, among others.
Tips remain subject to Social Security and Medicare taxes (FICA) at the federal level, and state and local taxes, as the deduction only applies to federal income tax.
Overtime, or “time-and-a-half,” pay that’s eligible for deduction under the bill includes only what exceeds an employee’s regular compensation rate — this would be the “half” portion of the total “time-and-a-half” pay.
The Associated Press contributed to this report.
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