Decoding the New Overtime and Tips Income Deductions

A Practical Guide for Service Workers and Employees Claiming Up to $25,000 in Tip Deductions and $12,500 in Overtime Deductions

New temporary tax deductions for tips and overtime income are providing meaningful relief for millions of service workers and hourly employees in the 2026 filing season. These changes were designed to support workers with volatile schedules, inconsistent income, and rising living costs by reducing taxable income in a tangible, easy-to-claim way.

This guide breaks down who qualifies, how the phase-outs work, and how these deductions can significantly increase refunds for working families.

Overview of the New Tip and Overtime Income Deductions

For tax year 2025 (filed in 2026), eligible workers may claim:

• Up to $25,000 in deductible tip income
• Up to $12,500 in deductible overtime income

Both deductions are temporary, income-restricted, and designed to be simple. They apply whether you take the standard deduction or itemize.

For many working households, these provisions will lead to one of the largest reductions in taxable income in recent years.

Who Qualifies for These New Deductions?

Eligibility is based on age, income, employment status, and the type of income you earn.

Tip Income Deduction: Who Qualifies

You may qualify if:

• You earned tips as part of your regular job (restaurant, hospitality, delivery, personal services, bartending, etc).
• Tips were reported on Form W-2 or allocated through employer payroll.
• Your Adjusted Gross Income (AGI) falls under the phase-out limits.

This deduction is available whether your tips are:

• Cash
• Card-based
• Pooled
• Distributed
• Automatically calculated (gratuity)

As long as the income is reported, it may be deductible up to the temporary limit.

Overtime Income Deduction: Who Qualifies

You may qualify if:

• You received overtime pay at time-and-a-half or double-time.
• Overtime was paid by an employer and reported on your W-2.
• You meet the AGI requirements for the deduction.

This deduction is aimed at hourly workers, essential employees, and workers who logged significant overtime shifts during 2025.

Income Phase-Out Limits: What You Need to Know

Both deductions include income-based phase-outs designed to target lower- and middle-income workers.

While the exact thresholds may adjust slightly based on filing status, payroll system guidance, and future IRS clarifications, the general structure is:

Tip Income Deduction Phase-Out

For most taxpayers, the $25,000 tip deduction begins phasing out once AGI exceeds a middle-income band. Higher-income earners will see:

• A partial deduction in the phase-out zone
• No deduction once AGI exceeds the upper threshold

Workers in restaurant, hospitality, and delivery industries typically fall well within the full deduction range.

Overtime Income Deduction Phase-Out

The $12,500 overtime deduction is phased out for higher AGI levels as well. The majority of hourly workers, essential workers, and manufacturing employees will qualify for at least a partial deduction.

Taxpayers should check 2025 Form 1040 instructions for the exact numbers when filing.

How These Deductions Increase Your 2026 Refund

These new deductions reduce the amount of income the IRS can tax. Unlike credits or complex adjustments, these are straightforward income reductions, which lead to:

• A lower tax bracket impact for many workers
• Direct reductions in liability
• Larger refunds when withholding exceeds the revised tax owed

How Much Can You Save?

For many families, these savings can be substantial.

Example Savings Estimates Based on Tax Brackets

Many working families may qualify for both deductions simultaneously, producing refund increases of several thousand dollars.

Can You Claim These Deductions If You Take the Standard Deduction?

Yes.
Both deductions apply in addition to the standard deduction.

You do not need to itemize to claim them. This makes the deductions accessible to:

• Most hourly workers
• Most restaurant and tip-based service employees
• Large families already using the standard deduction

Itemizers may also fully claim the deductions.

How to Claim the New Deductions on Your 2025 Tax Return

The IRS will add dedicated lines or worksheet instructions in the 2025 Form 1040 package. To prepare, workers should:

1. Keep Accurate Records

For tips:

• Daily tip logs
• Employer reports
• POS summaries
• W-2 Box 1 and Box 7 reporting

For overtime:

• Paystubs
• Payroll summaries
• Employer timekeeping reports

2. Check Updated Software

Ensure your tax software is updated for new 2025 tax law changes. Early versions may not include the deduction.

3. Confirm Your AGI

AGI determines whether you qualify for full or partial deduction.

4. File Electronically

This reduces errors and ensures the deduction is calculated automatically.

5. Keep Documentation for Three Years

The IRS recommends maintaining income documentation in case of wage-matching reviews.

Why These Deductions Were Created

The deductions were designed to support working-class employees who often experienced:

• Unpredictable schedules
• High tip fluctuations
• Mandatory overtime
• Wage-based inflation
• Reduced purchasing power

Service workers and hourly employees make up one of the largest workforce segments, and these provisions provide immediate, straightforward relief.

Who Benefits the Most?

These deductions primarily help:

• Restaurant servers
• Bartenders
• Hotel staff
• Delivery drivers
• Rideshare and service workers earning reportable tips
• Healthcare support staff
• Manufacturing and warehouse employees
• Retail workers
• Public safety and essential workers
• Shift-based employees with significant overtime

Households that combine tip income and overtime pay may see the biggest refund increases.

The new temporary deductions for tip income and overtime pay offer substantial opportunities for service workers and hourly employees to reduce taxable income and increase their refund for the 2026 filing season.

Workers who qualify and understand the phase-outs can save thousands by properly documenting and claiming these deductions on their 2025 return.

These provisions represent one of the most targeted forms of tax relief for working families in recent years.