New federal legislation is shaking up how tip income and overtime pay are taxed—at least temporarily. From 2025 through 2028, qualified employees could see major savings on their federal tax bill thanks to the No Tax on Tips Act and a new federal overtime deduction. Here’s what employers and employees need to know, and how it might (or might not) impact your paycheck.
What Is the No Tax on Tips Act?
Signed into law by President Donald Trump on July 4, 2025, as part of the One Big Beautiful Bill Act, the No Tax on Tips Act creates a federal income tax exemption for tip income—up to $25,000 per year—for employees in traditionally tipped jobs. This measure is in effect from January 1, 2025, through December 31, 2028.
What’s Exempt?
- Up to $25,000 per year in qualifying cash or electronic tips (Venmo, credit card, etc.)
- Applies to federal income tax only
- Covers workers in tip-eligible roles (e.g., food service, hospitality, salons, etc.)
What’s Not Exempt?
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- Tips are still subject to: Social Security tax (6.2%)
- Medicare tax (1.45%)
- Employer FICA match
- This is not a payroll tax exemption—withholding is still required on all tips for FICA purposes.
Who Qualifies?
Employees in tip-eligible occupations may qualify for the exemption if they meet the following criteria:
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- Adjusted Gross Income (AGI) thresholds: Full exemption if AGI is $150,000 or less (single) or $300,000 or less (married filing jointly)
- Phase-out: Exemption reduces by $100 for every $1,000 over the limit
- Only cash and electronic tips qualify
- Non-cash tips like tickets or items do not qualify
What Do Employers Need to Do?
Employers are still responsible for:
- Reporting all tips on Form W-2 (Boxes 1 & 7)
- Withholding and remitting FICA taxes on all tip income
- Following new IRS guidance (pending) for how to separately report exempt tips, likely via a new line or code on the W-2
Federal Overtime Deduction: Another Big Change
Alongside the tip income exemption, the law introduces a federal tax deduction for qualifying overtime pay. This is a year-end tax deduction for employees, not a payroll exemption.
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- Effective for tax years 2025–2028Deduction limits: Up to $12,500 (single)
- Up to $25,000 (married filing jointly)
- Deduction applies to gross overtime pay only
- Does not impact Social Security, Medicare, or payroll taxes
- No change to take-home pay throughout the year—savings apply when filing taxes
- Separate W-2 reporting for overtime income may be required (IRS guidance pending)
No Big Beautiful Change to Paycheck
Payroll tax rates and withholdings stay the same. Employees will not see a change in their net (take-home) pay with this Bill, but rather information on their W-2 that would allow a federal tax deduction on their 1040. Employers still need to report all tips/overtime worked and withhold payroll taxes as usual.
What About State Taxes?
Alabama’s Overtime Deduction Has Expired
Alabama initially aligned with the federal exemption for overtime income—but that state-level tax break expired on June 30, 2025. The state legislature shifted its focus to other tax relief measures, such as reducing the grocery tax, and is unlikely to revive the overtime deduction due to education budget constraints.
How FocusPay Can Help
At FocusPay Solutions, we help you stay ahead of payroll and tax compliance. We’ll keep your reporting accurate, your filings timely, and your team informed—so you can focus on what matters most: your business.
We are awaiting IRS reporting guidelines. FocusPay Solutions will continue to monitor both federal and state developments and provide updates as more information becomes available.
To learn more about how our payroll services can support your compliance efforts or any other human resource management services, please contact Katelyn Parks at (334) 321-4729 or leave a message below.
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