The Facts on Tax: Breaking Down the H.R. 1 Overtime, Tips Provisions

Ever since President Donald Trump signed H.R. 1, otherwise known as the One Big Beautiful Bill Act, on July 4, employers have sought clarification on what particular elements of the legislation mean for them, their businesses and their employees. Recurring questions, including some in WorldatWork’s Engage online community, have centered on the “no tax on overtime” and “no tax on tips” provisions.

This Workspan Daily article will get into the weeds on those two items within the new law and provide needed information to help you prepare for eventual implementation and compliance.

The Overtime Provision

“No tax on overtime” appears as Section 70202 within H.R. 1, spanning pages 257 to 263 in the 870-page document.

The general provision is: “There shall be allowed as a deduction an amount equal to the qualified overtime compensation received during the taxable year and included on statements furnished to the individual pursuant to Section 6041(d)(4) or 6051(a)(19) [of the Internal Revenue Code].”

Let’s get more granular on this and corollary statements.

When does this apply? The changes brought out by the provision are effective starting with the 2025 tax year and expire after the 2028 tax year.

How will the changes be made? The law requires the Internal Revenue Service (IRS) to reflect the new deduction in updated income tax withholding procedures and tax forms. The agency has not published subsequent guidance or deliverables as of the publication of this article.

Who does this apply to? The law defines “qualified overtime compensation” as “overtime compensation paid to an individual required under Section 7 of the Fair Labor Standards Act of 1938 that is in excess of the regular rate … at which such individual is employed.”

Under Section 7, “covered, nonexempt employees receive not less than one and one-half times their regular rates of pay for hours worked in excess of the applicable maximum hours standards.”

Section 13(a)(1) of the FLSA outlines that an employee is nonexempt unless they are paid a salary that is above a specified threshold (currently $35,568) and work in an executive, administrative, professional, computer or outside sales role.

In general, if the definitions apply to a segment of your workforce, the provision applies to you.

What are the deductions? Qualified U.S. workers can deduct up to $12,500 ($25,000 in the case of a joint return) in overtime pay from their annually income subject to federal income tax. This amount is reduced by $100 for each $1,000 in cases where the taxpayer’s modified adjusted gross income (MAGI) is greater than $150,000 ($300,000 in the case of a joint return).

What are the deduction caveats? The deduction does not apply to overtime premiums required under state laws or collective bargaining agreements. It also has no effect on Social Security and Medicare taxes. To prevent “double dipping” on new H.R. 1 tax deductions, qualified tips subject to the “no tax on tips” provision (explained below) can’t also be claimed as qualified overtime compensation. Also, the deduction is not allowed unless the taxpayer includes their social security number on their tax return.

What are the business requirements? Employers must keep a distinct record of the qualified overtime premium compensation and report it as a separate line item on IRS Form W-2 for employees and Form 1099 for nonemployees. For the 2025 tax year, the law allows the employer to “approximate a separate accounting of amounts designated as qualified overtime compensation by any reasonable method specified by the secretary [of the Treasury Department].”

What else should you know? Many law firms are hashing out and responding to employer “what-ifs,” such as “What if I switch up an employee’s classification from nonexempt to exempt (or vice versa) in response to the new law?” Toward that question, a post by employment law firm Littler Mendelson P.C. advised, “Employers should exercise extreme caution and consult legal counsel before implementing any compensation [or classification] changes designed to take advantage of this deduction. Many of the schemes that have been discussed are fraught with risk.”

The Tips Provision

“No tax on tips” appears as Section 70201 within H.R. 1, spanning pages 247 to 257.

The general provision is: “There shall be allowed as a deduction an amount equal to the qualified tips received during the taxable year that are included on statements furnished to the individual pursuant to section 6041(d)(3), 6041A(e)(3), 6050W(f)(2) or 6051(a)(18) [of the Internal Revenue Code], or reported by the taxpayer on [IRS] Form 4137 (or successor).”

Let’s delve into this statement and those that follow.

When does this apply? The changes are effective starting with the 2025 tax year and expire after the 2028 tax year.

Who does this apply to? This section of H.R. 1 uses the word “qualified” 12 times to put parameters on its application. Regarding individual workers from individual work groups, the statute spells out, “There shall be taken into account only tips received from customers or clients in connection with the following services: (A) The providing, delivering or serving of food or beverages for consumption, if the tipping of employees delivering or serving food or beverages by customers is customary; [and,] (B) The providing of any of the following services to a customer or client, if the tipping of employees providing such services is customary: (i) Barbering and hair care; (ii) nail care; (iii) esthetics; (iv) body and spa treatments.” The law notes that, for references and advisement purposes, the treasury secretary, on or before Oct. 2, will publish a list of occupations that “customarily and regularly received tips on or before Dec. 31, 2024.” So, watch for possible additions to the eligible-jobs list. Currently, workers in certain specified businesses (e.g., accounting, healthcare, law, actuarial science, athletics, brokerage services, consulting, financial services, the performing arts) are not eligible for the tips deduction. According to the Yale Budget Lab, around 4 million people — or around 2.5% of U.S. workers — are traditionally considered tipped workers.

What does this apply toward? “Qualified tips” are defined as for-service remuneration that is “paid voluntarily without any consequence in the event of nonpayment,” not the subject of negotiation, and determined by the customer/payer. While “cash tips” are the most common means toward deduction application, the law defines that term to include:

• Tips “paid in cash or charged” plus “tips received under any tip-sharing arrangement”; and,
• Tangible “non-cash” tips (e.g., concert tickets, a gift basket), listed in dollar-value equivalent.

Section 3 — most prominently, Section 3(m) — of the FLSA outlines the use of tips by employers as a form of compensation.

What are the deductions? Qualified U.S. workers can deduct up to $25,000 in tips (no increase is called out in the case of a joint return) from their annually income subject to federal income tax. Like the overtime provision, the amount is reduced by $100 for each $1,000 by which the taxpayer’s modified adjusted gross income (MAGI) exceeds $150,000 ($300,000 in the case of a joint return).

What are the deduction caveats? The deduction is available to nonitemizers, meaning such individuals, as individual income tax filers, can claim it in addition to the standard deduction. This deduction has no effect on Social Security and Medicare taxes. Also, the deduction is not allowed unless the tipped worker includes their social security number on their tax return.

What are the business requirements? For eligible tipped employees, employers must include the worker’s dollar amount for cash and non-cash tips, and the worker’s occupation, on Form W-2 (or otherwise report it on Form 4137). For tipped contractors that receive a Form 1099, employers must separately report the worker’s applicable tips and occupation on that tax form. For the 2025 tax year, the law advises, “Persons required to file returns or statements under section 6051(a)(19), 6041(a) or 6041(d)(4) of the Internal Revenue Code of 1986 (as amended by this section) may approximate a separate accounting of amounts designated as qualified overtime compensation by any reasonable method specified by the [treasury] secretary.”

What else should you know? Like the overtime provisions, the tips section of H.R. 1 is keeping many law firms busy answering questions. For instance, a post by employment law firm Ogletree Deakins shared guidance regarding impacts to the Federal Insurance Contributions Act (FICA) tip credit: “The credit permits employers to reduce taxable business income by the amount employers pay for the employer share of the Social Security and Medicare taxes (FICA tax) on certain employee tips. The employer share of the FICA tax is currently 7.65%. The act amends the Internal Revenue Code (IRC), which defines certain tips as eligible for the employer FICA tip credit. Currently, Section 45B(b)(2) of the IRC states that, for the purpose of calculating the employer FICA tip credit, only tips received by employees in connection with providing, delivering or serving food or beverages for consumption are taken into account if tipping is customary in that establishment. The act expands Section 45B to include beauty service businesses … where tipping is customary. The act does not, otherwise, affect employers’ ability to take advantage of the FICA tip credit.”

Editor’s Note: Additional Content

For more information and resources related to this article, see the pages below, which offer quick access to all WorldatWork content on these topics:

• Employee Compensation
• Finance and Budgeting
• Total Rewards