The IRS is introducing two powerful new deductions beginning in 2025—and they could lead to major tax savings for millions of hourly workers and service professionals.
But there’s a catch.
These deductions rely entirely on the accuracy of your payroll records. If your business isn’t tracking and reporting correctly, your employees could miss out—and you could face compliance issues down the road.
Here’s what you need to know.
The “No Tax on Tips” Deduction
From 2025 through 2028, employees (and some self-employed individuals) in occupations that customarily and regularly receive tips may be eligible to deduct up to $25,000 in qualified tip income.
Key highlights:
- Tips must be reported on a W-2, 1099, or Form 4137
- Only voluntary tips count—mandatory service charges do not
- Phases out for individuals with modified AGI above $150,000 ($300,000 for joint filers)
- Deduction is available to both itemizing and non-itemizing taxpayers
- Ineligible if you're self-employed in a Specified Service Trade or Business (SSTB), or employed by one
The IRS will release a list of qualifying occupations by October 2, 2025.
The “No Tax on Overtime” Deduction
Also effective from 2025 to 2028, individuals can deduct the “half” portion of time-and-a-half overtime compensation—essentially, the pay you earn for working extra hours beyond your regular rate.
Key details:
- Maximum deduction of $12,500 per year ($25,000 for joint filers)
- Phases out at the same AGI limits as above
- Only applies to qualified overtime pay that’s properly reported
Reporting Requirements You Can’t Ignore
Both deductions come with strict documentation rules:
- Employers must file information returns with the IRS or SSA
- Annual statements to employees must clearly show tip and overtime amounts
- Employers must list the employee’s occupation for the tip deduction
- Incomplete or inaccurate reporting can disqualify workers from claiming these deductions
Translation: your payroll system needs to be precise—especially when it comes to how tips and overtime are tracked, categorized, and reported.
Why This Matters for Your Business
The deductions themselves don’t create more work—but the failure to properly track and report definitely will. These changes aren’t optional, and the IRS is expected to scrutinize filings closely once the rules go into effect.
If you run payroll for employees in tip-heavy or overtime-heavy industries—restaurants, hospitality, salons, construction, healthcare—now is the time to assess your processes and ensure everything is compliant before 2025.
Final Thoughts
These new IRS deductions represent a real opportunity to support your workforce and reduce their tax burden. But the benefits only apply when the records are right.
If you’re not confident in your payroll tracking or reporting systems, we can help. We support tax professionals and business owners in ensuring compliance while maximizing strategic savings opportunities.
Recommended Payroll Platform: Hourly
If you're looking for a reliable, easy-to-use payroll solution that makes tracking tips and overtime straightforward, we recommend Hourly.
- Built for industries that rely on hourly workers, tips, and overtime
- Integrates seamlessly with QuickBooks Online
- Lets you run payroll straight from your phone
- Supports payroll adjustments and out-of-cycle checks—at no extra cost
Hourly is a great option if you want to stay compliant and efficient as these IRS changes roll out. It’s designed to help you keep payroll accurate and IRS-ready—without adding friction to your workflow.
