New Overtime and Tip Tax Break Affects Paychecks Starting 2025

Washington, D.C. — Congress has approved a significant tax change targeted at employees earning tips and overtime pay, set to take effect for income earned starting January 1, 2025. The new law eliminates federal income tax on up to $25,000 in tips and $12,500 in overtime, beneficial for many workers.

The legislation, which was finalized just before the July 4 deadline, covers various issues but has generated particular attention for its provisions on tax deductions. Polls show that while overall support for the broader bill is low, the tip and overtime tax cut remains popular, with consistent backing from employees.

The deductions will first impact workers when they file their tax returns in early 2026. However, there are crucial limits to keep in mind. These deductions phase out for single filers earning over $150,000 and couples earning over $300,000. Additionally, the tips and overtime must be reported on a W-2 or 1099 and should come from industries recognized by the Treasury as “customarily tipped.”

Employers will still withhold FICA and Medicare taxes, as the new law only affects federal income tax. Furthermore, the tax break is not permanent; the deductions are slated to end on December 31, 2028, unless Congress chooses to extend them.

In response to these changes, some states are considering similar measures. For instance, Massachusetts Representative Marc Lombardo has introduced a bill to eliminate state income tax on overtime with no cap, although progress has stalled.

For employers, the transition may prove challenging. They are required to report the new amounts in 2025, but the IRS will not update withholding tables until 2026. This could lead to potential confusion for HR departments and payroll providers.

As the implementation date approaches, taxpayers are encouraged to monitor updates from the IRS this fall for details on how these changes will impact their paychecks and tax returns.