Tax-Free Tips and Overtime: What the Big Beautiful Tax Bill Means for Workers
The Big Beautiful Tax Bill introduced two worker-friendly provisions aimed at boosting take-home pay: tax-free tips and tax-free overtime pay.
By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group
The Big Beautiful Tax Bill introduced two worker-friendly provisions aimed at boosting take-home pay: tax-free tips and tax-free overtime pay.
Starting in 2025, many employees in service-based and hourly industries will see a new opportunity to earn more without increasing their federal tax bill. But before you get too excited, there are income phaseouts that limit the benefit for higher earners, and both provisions are temporary—ending in 2028.
Let’s break down how each works, who qualifies, and how you might use this limited-time tax relief to your advantage.
Tax-Free Tips (2025–2028)
Under the new law, cash and electronic tips earned by employees will be excluded from federal income tax starting in 2025. This means waitstaff, bartenders, valets, and other tipped workers can keep more of their tips without paying federal income tax on that income.
Key Details:
Up to $25,000 of qualified tip income is deductible
Applies to all reported tips, including cash, credit card, and digital payment platforms (like Venmo or Square).
Employers are still required to track and report tip income, but it won’t count toward federal taxable wages.
FICA (Social Security and Medicare taxes) still apply to tips unless further guidance says otherwise.
Income Phaseouts for Tax-Free Tips
The benefit is phased out for higher earners. Once your income reaches a certain threshold, the tax-free status begins to shrink—and disappears entirely once fully phased out. The $25,000 deduction amount is reduced by $100 for each $1,000 of modified AGI over $150,000 for single filers and $300,000 for joint filers.
If you’re within the phaseout range, the portion of your tips that are tax-free decreases gradually until it reaches zero.
Tax-Free Overtime Pay (2025–2028)
In a rare move to incentivize additional work hours, the bill also makes overtime pay exempt from federal income tax from 2025 through 2028. This applies to time-and-a-half wages earned beyond 40 hours per week.
Key Details:
Up to $12,500 ($25,000 joint) of qualified overtime compensation is deductible
Applies to hourly workers eligible for overtime under the Fair Labor Standards Act.
Only the premium portion of overtime (typically the 1.5x wage rate) is tax-free. The base rate is still taxable.
Overtime must be properly documented on pay stubs or employer payroll systems.
Income Phaseouts for Tax-Free Overtime
As with tax-free tips, this benefit is designed to help middle-income earners and begins to phase out at higher income levels. The phaseout calculation is the same as the tips deduction, the $12,500 deduction is reduced by $100 for each $1,000 of modified AGI over $150,000 (single) and $300,000 (joint).
If your income falls within the range, only a portion of your overtime premium pay will be excluded from taxes. Above the threshold, none of the overtime qualifies for the exemption.
Could Employers Shift Salaried Workers to Hourly?
One of the more interesting (and perhaps unintended) consequences of the tax-free tips and overtime provisions is that it may incentivize employers to reclassify certain employees from salaried to hourly.
Here’s why:
Only hourly workers are eligible for tax-free overtime under the new law.
Salaried employees—particularly those exempt from overtime rules—don’t benefit at all from this provision.
Employers looking to attract and retain workers in a competitive labor market may consider restructuring compensation models to help employees take advantage of the new tax savings.
For example, a business might:
Reclassify a lower-level manager from salary to hourly, allowing them to earn overtime that’s now tax-free.
Shift part of a base salary into a tip-eligible role (such as hybrid front-of-house service positions) to access the tax-free tip benefit.
Of course, this type of reclassification must be done carefully to remain compliant with wage and hour laws, and may not be appropriate in every industry. But in sectors like hospitality, healthcare, retail, and logistics, this kind of shift could become more common—particularly as employees become more aware of the tax advantages.
Planning Considerations
These two provisions present real planning opportunities for wage earners, especially those working in hospitality, retail, healthcare, and skilled trades.
1. Stack Your Hours Smartly
For hourly workers who are near the phaseout thresholds, it may make sense to shift hours into lower-income years to maximize the benefit.
2. Watch for Unintended Phaseout Triggers
Bonuses, side gigs, or spousal income could push you into the phaseout range and reduce or eliminate your tax-free eligibility. Tax planning with a professional can help you anticipate this.
3. Use the Extra Take-Home Pay Wisely
Since these benefits are temporary (expiring at the end of 2028), consider putting the extra income to work:
Pay down high-interest debt
Build your emergency fund
Contribute more to retirement or a Roth IRA
Save for large purchases without relying on credit
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Frequently Asked Questions (FAQs):
What are the new tax-free tip and overtime provisions under the Big Beautiful Tax Bill?
Starting in 2025 and lasting through 2028, workers can exclude certain tip income and overtime pay from federal income tax. Up to $25,000 in tips and up to $12,500 ($25,000 for joint filers) in overtime pay may qualify each year, subject to income limits.
Who qualifies for the tax-free tip provision?
Hourly and service-based workers who earn tips—such as restaurant servers, bartenders, or valets—can exclude up to $25,000 of reported tip income from federal income tax. The deduction phases out for single filers with income above $150,000 and joint filers above $300,000.
How does the tax-free overtime pay rule work?
Hourly employees eligible for overtime under the Fair Labor Standards Act can exclude the “premium” portion of overtime pay (the extra half-time pay above their base rate) from federal income tax. The same income phaseouts apply as for tips.
Do workers still pay Social Security and Medicare taxes on tax-free tips and overtime?
Yes. Even though the new law exempts certain tips and overtime from federal income tax, FICA taxes (Social Security and Medicare) still apply unless further IRS guidance states otherwise.
Will salaried employees benefit from the new provisions?
No. Only hourly workers qualify for the tax-free overtime benefit. Some employers may consider reclassifying certain employees as hourly to allow them to take advantage, but any reclassification must comply with labor laws.
How long do the tax-free tip and overtime benefits last?
Both provisions are temporary. They take effect in 2025 and are scheduled to expire at the end of 2028 unless Congress extends them.
What should workers do with the extra take-home pay?
Since the benefits are short-term, consider using the additional after-tax income to pay down high-interest debt, build savings, or contribute to retirement accounts. A financial professional can help you plan the most effective use of the extra cash flow.
