No tax on tips and overtime: Here’s how your taxes may shrink

In a sweeping shift poised to reshape the tax landscape for millions of American workers, President Donald Trump signed the massive tax bill into law on July 4, thus fulfilling one of his major campaign promises to eliminate federal income taxes on some tips and overtime pay.

Trump first pledged to end taxes on tips during a campaign rally in Las Vegas in 2024, aiming to win support of voters in the swing state. The megabill, which cleared the Senate and House this week, marks one of the most significant federal tax policy changes in recent years. 

Under the new law, workers who rely on tips or work extra hours will be able to keep more of their earnings — a move the White House claims will boost pay for working-class Americans.

But not everyone agrees. A study by the Tax Policy Center found that while some taxpayers may see an increase of a few hundred dollars in after-tax income, many low-income earners could see little to no benefit at all. 

Here’s how the new law works — and what it could mean for your taxes.

Overview of no taxes on tips or overtime pay

No taxes on tips

No taxes on overtime pay

What ‘no tax on tips’ could mean for you

Workers 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. 

The new tax law creates a 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 starts to phase out for taxpayers with modified adjusted gross income (MAGI) of $150,000, or $300,000 if married filing jointly. (The value of the deduction will drop by $100 for every $1,000 of income above those amounts.)

“​​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 deductions for tips are available to non-itemizers, so they can be claimed even if the taxpayer claims the standard deduction.”

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

The tax break won’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.  

Who benefits the most?

While this provision will 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. 

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.

A hefty new tax cut on overtime pay

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

“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 overtime tax break will function similarly to the tip income deduction. Overtime wages will 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 will apply to tax years 2025 through 2028. 

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

Effect on federal revenues 

While some experts say workers who earn overtime and tip income will pay less taxes under the new law, others warn the measure will increase the federal deficit and result in a significant loss of revenue. 

The Joint Committee on Taxation estimated 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 estimated 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.