As most employers probably are aware, the recently enacted comprehensive tax, budget, and policy legislation (HR 1) includes specific changes to the Internal Revenue Code that are designed to implement President Trump’s campaign promises to “eliminate taxes on tips and overtime.” While those provisions represent significant changes in tax policy, they do not actually create significant new burdens for employers.
Deduction for Qualified Tips
Under the new law, tipped employees may deduct from their federal taxable income the amount that they receive over the course of the year in “qualified tips.” The deduction only is available to individuals working in occupations in which employees “customarily and regularly received tips” prior to 2025; the Treasury Department is charged with publishing a list of such occupations that can qualify for the deduction. The deduction also is subject to a cap of $25,000.00, and the deduction starts to phase out for employees whose adjusted gross income exceeds $150,000.00 (or $300,000.00 for a joint return).
Although the law does not define what a “tip” actually is, it does state explicitly that a payment cannot qualify as a “tip” unless it is “paid voluntarily without any consequence in the event of nonpayment” and “is not the subject of negotiation.” The law also provides that a payment cannot constitute a “tip” unless it is “determined by the payor.” That clause raises a question about whether the type of fixed “service charges” or specified “gratuities” that some restaurants, bars, or other hospitality providers automatically add to checks for large parties will qualify for the deduction. The bill authorizes the Treasury Department to issue regulations and other guidance to implement the deduction; we anticipate that the Department or IRS will deal with that issue in such regulations.
Deduction for Overtime Compensation
The new law also permits employees to deduct from their federal taxable income the amount that they receive over the course of the year in “qualified overtime compensation.” The deduction is subject to a cap of $12,500.00 ($25,000.00 for a joint return). Like the deduction for qualified tips, the deduction for overtime compensation similarly starts to phase out for employees whose adjusted gross income exceeds $150,000.00 (or $300,000.00 for a joint return).
The law applies to overtime compensation that is paid under the Fair Labor Standards Act. Under the FLSA, of course, a non‑exempt worker is entitled to payment at “time and a half” his or her “regular rate” for all “hours worked” in excess of 40 hours in the week.
The law defines “qualified overtime compensation” as overtime pay “in excess of the regular rate at which the individual is employed.” Under that language, the deduction does not apply to all dollars paid to compensate a worker for overtime that he or she may work in any given week; the deduction only applies to the “and a half” portion of the worker’s overtime pay.
Obligations for Employers
The only real legal obligation that these provisions place on employers is to include the total amount of each employee’s qualified tip income and qualified overtime compensation, if any, on the employee’s W‑2 form each year (starting with W‑2s for 2025, to be issued by January 31, 2026).
Most companies with tipped employees already have the capacity to track employees’ reported tips, of course (to take advantage of the tip credit against the minimum wage). And every employer with non‑exempt personnel already must accurately record all overtime hours worked and all overtime compensation paid. As a practical matter, therefore, the only task remaining for most employers will be to ensure that their payroll and accounting systems are enabled to report total annual tips and total annual qualified overtime pay on employees’ W‑2 forms.
We expect that the Treasury Department or IRS will take steps later this year to publicize revisions to the standard W‑2 form to include new “boxes” for those amounts, to enable employees to use those figures when completing their own federal income tax returns.
We encourage employers who have specific questions about HR 1’s provisions on tips and overtime compensation (or any employment law topic) to contact Don Johnsen or any other member of Gallagher & Kennedy’s Employment & Labor Law practice.
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about the author
Don Johnsen represents employers in matters involving employment discrimination and sexual harassment, wrongful discharge, breach of contract, wage and hour disputes, arbitrations, and labor practice charges. Practicing employment and labor law exclusively, Don advises on employee hiring, discipline and discharge procedures, drug and alcohol testing, non-competition matters, labor relations issues, and other employment-related policies and procedures.