A Trump-backed tax plan currently advancing through Congress proposes significant changes to the federal taxation of overtime pay and tip income. Passed by the House on May 22, 2025, the “One Big Beautiful Bill Act” includes provisions that could allow eligible workers to exclude certain overtime earnings and tips from their taxable income. These measures aim to provide financial relief to workers in industries where overtime and tipping are common.
A financial advisor can help you assess how these proposals may impact your tax situation and financial planning strategies.
- The Trump-backed tax bill would let eligible workers exclude certain overtime and tip income from federal taxes.
- To qualify, income and job-type restrictions apply, and proper reporting is required.
- Senate Republicans may revise or reduce these proposed breaks to fund permanent business tax cuts.
Potential New Tax Breaks for Workers: Overtime Pay and Tips
As part of the proposed tax plan making its way through Congress, two new tax breaks could significantly benefit hourly workers and employees who rely on tips. These changes aim to reduce taxable income for millions of Americans by excluding certain types of earnings from federal income tax.
You should note, however, that Senate Republicans in June have said that they want to trim parts of Trump’s House-approved tax plan, which includes provisions for no tax on tips and overtime. This would help pay for making business tax breaks permanent. Both chambers are working on procedural changes to address reconciliation rules without requiring separate votes on bill revisions.
Overtime Pay May Become Tax-Deductible
Under the proposed plan, workers could soon be able to deduct qualified overtime earnings from their federal taxable income. This means that if they work more than the standard 40 hours per week, extra pay received for those hours wouldn’t be taxed like regular income.
To qualify, overtime pay must:
- Be earned under the Fair Labor Standards Act rules for hours worked beyond the standard workweek.
- Not be considered “tip income” (i.e., it can’t also be money you received as tips).
However, not everyone will be eligible. The deduction does not apply to:
- Highly compensated employees (generally those earning above a certain threshold as defined by the IRS).
- Overtime earnings already treated as tips.
You’ll also need to provide your Social Security number – and if filing jointly, your spouse’s – when you file your taxes to claim the deduction.
This change would apply to tax years starting after December 31, 2024, and before January 1, 2029.
How This Differs From the Current Law:
Right now, all overtime pay is treated as regular income and taxed at your ordinary income rate. There’s no special tax treatment for working extra hours. This proposed change could lower the tax bills of hourly employees who frequently work overtime.
Cash Tips Could Be Excluded From Taxable Income
Another major change under the proposal affects employees who earn tips, such as servers, bartenders, hairstylists and other service industry workers in qualified jobs. If the law passes, qualified tips could be deducted from your taxable income, meaning you won’t pay federal income tax on them.
To qualify, the tips must:
- Be cash tips paid voluntarily by customers (not service charges or mandatory gratuities).
- Be received in a job that traditionally involved tipping before December 31, 2024.
- Be properly reported on tax forms, such as Form 4137. This is the form used to calculate Social Security and Medicare tax on tip income.
There are some limitations. The deduction would not apply to tips earned in certain high-income industries or specific service settings that the IRS may define in regulations. Also, as with the overtime provision, you’ll need to include your Social Security number on your return to qualify.
This provision would apply to tax years beginning after December 31, 2024, and ending after December 31, 2028.
How This Differs From the Current Law:
Today, all tips, cash or otherwise, are considered taxable income and must be reported to the IRS. Employees are expected to pay income tax on these earnings, regardless of whether they’re reported by the employer or employee. This proposal could exempt a significant portion of tip income from federal taxation, providing relief to many low- and moderate-income worker
Determining Qualification: A Guide to the Proposed Tax Exemptions
While the proposed tax exemptions on overtime pay and tip income are designed to offer financial relief to a broad segment of the workforce, they come with defined limitations. It’s important for both employees and employers to understand who qualifies, and under what conditions.
Overtime Pay Exclusions
- Scope of the deduction: The tax deduction applies specifically to the additional compensation received for overtime work, not the full overtime wage. For example, if an employee earns a base wage of $20 per hour and receives $30 per hour for overtime, the deductible portion would be the $10 per hour premium, not the entire $30.
- Income threshold: Workers with an adjusted gross income exceeding $160,000 in 2025 would not be eligible for the deduction. This threshold is set to adjust annually for inflation.
- Deduction limit: The amount that can be deducted for overtime is capped at 20% of the employee’s regular wages from the same employer. As a result, the tax benefit is constrained even for those who frequently work overtime.
- Non-qualifying overtime: Overtime pay that is categorized as tip income or that does not meet the standards established under the Fair Labor Standards Act (FLSA) would not be eligible for the deduction.
Tip Income Exclusions
- Income threshold: Employees with annual earnings exceeding $160,000 are excluded from the tip income tax exemption.
- Occupational limitations: The exemption applies only to workers in occupations that traditionally received tips before December 31, 2024. The Treasury Secretary is tasked with releasing a list of eligible occupations, which may exclude newer or unconventional tipped roles.
- Reporting requirements: To qualify, tips must be properly reported on tax forms, such as Form 4137. Failure to report tips accurately can disqualify workers from the exemption.
- Impact on benefits: Critics warn that excluding tip income from taxable earnings could inadvertently affect workers’ eligibility for certain federal benefits. These may include the Earned Income Tax Credit (EITC), which are based on reported income levels.
Bottom Line
The proposed tax exemptions for overtime pay and tip income represent a notable shift in federal tax policy, potentially affecting millions of American workers. While these measures are designed to increase take-home pay for eligible employees, they come with specific qualifications and limitations. As the “One Big Beautiful Bill Act” continues through the legislative process, staying informed about its provisions can help taxpayers estimate future tax bills. A financial advisor can help explain how these potential changes may influence your tax obligations and overall financial planning.
Tax Planning Tips
- A financial advisor can help you create a plan to manage your tax liability. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to know how much your next tax refund or balance could be, SmartAsset’s tax return calculator can help you get an estimate.
Photo credit: ©iStock.com/Khanchit Khirisutchalual, ©iStock.com/Khanchit Khirisutchalual, ©iStock.com/Daenin Arnee
Read the full article here
