New in 2025: Overtime & Tip Deductions Explained

 

If you or your employees earn extra income through overtime or tips, there’s a brand-new tax break that could save thousands of dollars. Thanks to the One Big Beautiful Bill, starting in 2025, taxpayers can deduct a portion of their overtime and tip income, even if they take the standard deduction. This is a major change that affects both workers and small business owners who employ them.

Here’s everything you need to know.

 What’s New?

Beginning January 1, 2025 (through 2028), the IRS will allow:

• Up to $12,500 of overtime income to be deducted

• Up to $25,000 of tip income to be deducted

And here’s the best part: these are above-the-line deductions. That means they reduce your Adjusted Gross Income (AGI) directly, which can also lower your taxable income and potentially help you qualify for other credits or deductions.

This change is designed to provide immediate relief for hourly workers, tipped employees, and gig economy earners — but it also has important implications for small business owners.

 Who Qualifies?

This deduction is not limited to one industry or job type. You may qualify if:

• You earn overtime pay as an hourly employee

• You receive tip income in industries such as hospitality, delivery, beauty services, or rideshare

• You work a side hustle where tips or extra shifts make up a significant portion of your income

Income limits:

• Single filers: Full deduction available up to $150,000 AGI

• Married filing jointly: Full deduction available up to $250,000 AGI

• Above these thresholds, the deduction phases out gradually

This structure ensures that the benefit targets middle-income taxpayers who need it most.

 How Much Could You Actually Save?

While the headline numbers sound big, your savings depend on how much overtime and tip income you earn. Here’s what it might look like:

 What Business Owners Should Do?

If you run a small or mid-sized business, this change is an opportunity to support your employees while staying compliant. Here’s how:

1. Update payroll tracking: Make sure overtime and tip income are recorded accurately and separately.

2. Educate your team: Many workers won’t know about this deduction. Helping them understand it builds trust and loyalty.

3. Plan ahead for 2025: Incorporate these deductions into tax planning early to avoid surprises during filing season.

4. Work with a tax professional: This deduction is new. Proper guidance ensures compliance and maximizes the benefit for both employers and employees.

 Why This Matters for Small Business?

This deduction isn’t just for workers. As a business owner, you benefit when your employees take home more money. Financial relief can improve retention, reduce turnover, and make your workplace more competitive.

In addition, understanding these deductions helps you integrate them into payroll guidance and year-end planning — avoiding headaches for both you and your team.

 Pro Tip for Gig Workers and Side Hustlers

If you juggle multiple jobs or freelance work, you could combine overtime and tip deductions. For example, a delivery driver who earns overtime at a primary job and tips from a side gig may be able to deduct both — up to the maximum limits.

 Final Thoughts

The 2025 Overtime & Tip Deduction is one of the most practical in the new bill, taxpayer-friendly changes in years. It won’t eliminate your tax bill, but it can create meaningful savings for workers and give business owners another way to support their teams.

By tracking income accurately and planning ahead, you can make the most of this deduction — and stay one step ahead of tax season.

 Need help building a tax plan that includes the new deductions?
Contact KFM today. We’ll help you navigate every rule and maximize every dollar.