What Does “No Tax” on Tips or Overtime Mean for the 2026 Tax Year?
The IRS defines gross income as all accessions of wealth. Therefore, when a customer leaves extra funds on a check as a token of appreciation, employees receiving those funds must generally pay taxes, and employers must properly document all income as part of their separate reporting obligations. For businesses and workers seeking clarity on no tax on tips, Monty & Ramirez, LLP regularly advises on how federal wage and tax rules apply in real-world workplaces.
The One Big Beautiful Bill altered the Federal Tax Code as we know it. Title 7 of the bill contains key provisions such as “no tax on tips or overtime”. These “no tax” benefits are implemented in the form of additional deductions, which individuals can take in addition to the standard deduction. As a result, employers must review their payroll systems, educate their employees, and HR personnel.
Understanding the “No Tax on Tips”
Qualified tip wages are defined as any cash, funds left on electronic payment systems, the value of any noncash tip, and tips received from other employees paid out through tip-sharing arrangements received by an individual in an occupation that customarily and regularly receives tips. From 2025 to 2028, employees may deduct their qualified tips to reduce their tax bill.
The initial responsibility of reporting tips is on the employee. Employees must report tips received in writing by the 10th of the month after they get the income. For example, an employee who earns tips on January 1, 2026, has until February 10, 2026, to report the additional income to their employer. In sum, the employee has one month plus 10 days after they earned the tip to tell you about it.
Service charges are not treated as deductible tips. Service charges are fees that automatically apply to customers and are determined by the business. For example, when a party of 6 is charged $50 as a condition to receive service, that does not qualify for the tips deduction because the customer had no choice but to pay the charge to receive service. Even if the employee gets the full amount of the service fee, that does not qualify as a qualified tip eligible for a deduction. But service charges still qualify as gross income for the employer, regardless of whether they are distributed to the employee.
Qualifying Occupations
Only those jobs that made it onto the government’s list on or before December 31, 2024, qualify for this designation. Employers and Employees can go to the IRS website to see if their profession qualifies.
Examples include:
| Beverage & Food Service | Entertainment & Events | Home Services | Personal Services | Appearance & Wellness |
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Tracking Different Categories of Wages
Employers are required to keep records of employee tips and withhold taxes in accordance with federal laws and, if applicable, state laws. When W-2 forms are prepared, employers must record all reported tips in Box 1. With these changes, employees may begin to scrutinize pay stubs, making it more important than ever to comply with FLSA overtime pay laws, because as they attempt to keep track of their tips, this could lead to other lawsuits.
Overtime Premium Pay
Similarly, employees may deduct overtime income earned. The maximum annual deduction is $12,500 for single taxpayers and $25,000 for married filing jointly taxpayers. Since this deduction works retroactively, employers must report to the IRS and workers the amount of qualified overtime paid to the worker starting January 1, 2025.
Unlike the tips which will be reported on employees’ W-2s, there won’t be a separate box for overtime pay received in 2025. Thus, to take advantage of this new deduction, employees have to make their own calculations.
Overtime is defined by the FLSA as all wages earned by employees working more than 40 hours a week. This makes the employee eligible to receive additional income beyond their regular rate. But this deduction does not allow the employee to deduct all overtime income generated. To determine what portion is deductible, employees should consult with tax professionals.
What Changes Should Employers Implement?
To avoid confusion, employers should educate employees that overtime information will not show up on their W-2 this tax year, but employers can provide an estimate of all income generated from overtime wages. Similarly, employers can educate their employees that the “no tax” options are implemented as deductions, which they can take advantage of when they file their tax returns.
With the start of the new year and tax season, employers can be proactive by updating their handbooks to include a simple explanation of these tax changes.
Get Legal Guidance on No Taxes on Tips and Overtime Deductions
The new rules allowing no taxes on tips and certain overtime income can create both opportunities and compliance risks for employers and workers. From proper wage classification to accurate reporting and payroll practices, even small mistakes can trigger audits, wage disputes, or FLSA claims. The attorneys at Monty & Ramirez, LLP help businesses and employees understand how “no taxes on tips” deductions work, how overtime must be tracked, and what steps are required to stay in full compliance with federal and state labor and tax laws.
If you have questions about how no taxes on tips or overtime deductions affect your workplace, payroll system, or potential legal exposure, speak with an experienced employment law team today. A consultation with Monty & Ramirez can help you protect your rights, avoid costly errors, and move forward with confidence under the new tax rules.