No parts of the OBBBA have been more misunderstood than these two. Let’s provide some clarity for you here!
So, what does the law mean when it refers to “No Tax on Tips?” Not what you might think if you only read the headline. Let’s explore what we know right now:
- First off, the change is temporary. The tax deduction for tip income is only for 2025-2028.
- The deduction is limited to $25,000 per individual per year of qualified tip income that is received and reported as tax laws require.
- The deduction does not reduce adjusted gross income, only taxable income.
- The tips must be received in an occupation that customarily and regularly received tips as of 12.31.2024. This means you can’t suddenly call part of your income “tips” when you didn’t before. Sneaky, huh?
- “Cash tips” include both cash and charged tips as well as tips received under a tip-sharing arrangement.
- This tax deduction is not allowed for Married, Filing Separately status. An eligible individual must file a joint return if married.
- There are separate rules concerning self-employed individuals beyond the scope of this blog, but please consult your tax professional if you are self-employed and receive tips.
Are there income phaseouts? Come on, you know there are!
- The deduction is reduced if the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 for joint filers). So, while there are phaseouts, they’re somewhat generous.
How do you know what your tip income is? Well, it’s easy (sort of). Those tips need to be reported on a wage or 1099 form or reported to the taxpayer on Form 4137. What we see nearly 100% of the time is tip reporting on your W2. If your tips are run through payroll, we can easily identify the information on Form W2. There may be more changes coming for employers in how they report, but we don’t have anything on that just yet. Please note that mandatory service charges do NOT count as tips.
Now, let’s explore what we know about the “No Tax on Overtime” changes. Again, the devil is in the details.
- Like the tip changes, it’s temporary and applies to years 2025-2028.
- The deduction is limited to $12,500 (or $25,000 for joint filers) per year of “qualified overtime compensation” received and reported as required.
- Like the tip income deduction, this deduction doesn’t reduce adjusted gross income, only taxable income.
- What part of the wages are subject to this deduction? The number of hours worked at the premium rate, not the number of hours x the total hourly rate. What I mean by that is this: If your hourly rate is $20/hour, your OT rate is $30/hour. Your OT deduction would be determined as OT hours worked x $10/hour, which is the “premium” earned over regular pay.
Are there income phaseouts? What a silly question….
- The deduction is reduced if the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 for joint filers).
How in the world will you differentiate regular pay and overtime pay? The law says that employers will be required to separately report the overtime compensation on Form W2. As of now, we have no guidance on how that will happen. I feel bad for our payroll partners and those small businesses that prepare their own W2s. I fear this could be painful.
Tax law changes don’t often only impact those who qualify…they also impact the small businesses who report information to IRS, their state, and to the employee. Be patient with your employers and payroll professionals who are just now trying to figure out how to comply with these changes. As always, we’ll keep you posted as we learn more. I’m sure there is a ton of future clarification on the way!
Please remember that these tax law changes are brand new, and clarification is coming over the next few months. We are providing this guidance based on our understanding of the law as it is written, but the facts could change as we learn more. Please do not make changes to your income or tax position solely based on this blog post, as it is not considered to be tax planning advice. Make sure to consult your tax professional if you have specific questions about your situation.