Starting with 2025, the IRS lets millions of workers deduct tips and overtime pay from federal taxable income. It is the most asked-about change from the 2025 tax law, and also one of the most misunderstood. Headlines said "no tax on tips." The real rule is a deduction with caps, income limits, an occupation list, and a New York twist that changes in 2026.
The short version: For 2025 through 2028, you can deduct up to $25,000 of qualified tips and up to $12,500 of qualified overtime premium ($25,000 on a joint return) on your federal return, using the new Schedule 1-A. Both shrink once modified AGI passes $150,000 ($300,000 joint). Social Security and Medicare tax still apply. New York now excludes up to $25,000 of tips from state tax starting with 2026, but overtime stays fully taxable in New York.
What the deduction actually does
It is a deduction, not an exemption. Your tips and overtime still appear in your wages, still have payroll taxes taken out, and still count toward Social Security. What changes is that you subtract the qualified amount when figuring federal income tax.
Two details make it more generous than most deductions:
- You do not need to itemize. You claim it on Schedule 1-A on top of the standard deduction.
- It does not lower your AGI. It is taken after AGI is figured, which matters for New York (more on that below) and for anything else tied to AGI.
| Tips | Overtime | |
|---|---|---|
| Years | 2025 to 2028 | 2025 to 2028 |
| Annual cap | $25,000 per return | $12,500 ($25,000 married filing jointly) |
| What counts | Voluntary cash or card tips in a tipped occupation | Only the overtime premium the federal law requires |
| Phase-out starts | $150,000 MAGI ($300,000 joint) | $150,000 MAGI ($300,000 joint) |
| Payroll taxes | Still owed | Still owed |
| Where you claim it | Schedule 1-A, Form 1040 | Schedule 1-A, Form 1040 |
| New York State | Excluded up to $25,000 from 2026 | Fully taxable |
Above the income threshold, each deduction drops by $100 for every $1,000 of extra modified AGI. You also need a Social Security number valid for work, and if you are married you must file jointly to claim either one.
Which tips qualify
Qualified tips are amounts a customer chooses to pay, in cash or on a card, in an occupation that customarily received tips before 2025. The IRS has published a list of those occupations, covering roles like servers, bartenders, hair stylists, barbers, nail techs, valets and delivery drivers.
What does not count:
- Mandatory service charges and automatic gratuities. If the restaurant adds 18% for a party of eight and the guest cannot change it, that is a service charge, not a tip.
- Tips you never reported. The tips have to show up on a W-2, a 1099 or another statement, or be reported by you on Form 4137.
- Tips in a "specified service" business, such as health, law, accounting or consulting.
Self-employed tipped workers, like a booth-rent stylist, can claim it too, but the deduction cannot exceed the net profit from that work.
Which overtime qualifies
This is where most people overestimate the break. Only the premium counts, and only the premium the federal Fair Labor Standards Act requires.
If you earn $30 an hour and work overtime at time and a half ($45), the deductible part is the extra $15 for each overtime hour, not the full $45. Double time, holiday pay and union-contract premiums above the federal requirement do not add to the deduction. Salaried workers who are exempt from overtime under federal law get nothing here.
For 2026, employers report qualified overtime on the W-2 in box 12, code TT, and the new W-2 also has spaces for qualified tips and your tipped occupation. Use what your employer reports rather than your own math from pay stubs. For 2025, many W-2s did not show these amounts separately, so workers had to rebuild them from pay records.
What it is worth: two local examples
A server in White Plains. She earns $38,000 in wages plus $18,000 in reported credit card and cash tips. All $18,000 qualifies. In the 12% federal bracket, the deduction saves her about $2,100 in federal tax. Starting with 2026, New York also lets her exclude the $18,000, which saves several hundred dollars more on the state return.
A warehouse lead in Yonkers. He earns $30 an hour and works 300 overtime hours at $45. His qualified overtime is the $15 premium times 300 hours, or $4,500. In the 22% bracket, that saves about $990 federal, and nothing on his New York return, because New York taxes overtime in full.
Neither one escapes Social Security and Medicare tax on that pay, and neither should expect a check from this: the savings show up as a bigger refund or a smaller balance due when the return is filed.
The New York rule changed for 2026
New York starts its income tax from your federal AGI. Because the federal tips and overtime deductions come after AGI, they never reached the New York return on their own. For 2025, New York gave no relief on tips or overtime.
The state budget signed in May 2026 changed that for tips only. For tax years 2026 and later, New York excludes up to $25,000 of qualified tips from state income, following the federal definition. Overtime was not included, so overtime stays fully taxable for New York.
New York City's resident income tax is built on the state's, and the city's budget office has already estimated the revenue it loses from the tips break, so NYC residents should expect the same treatment. Check the 2026 IT-201 instructions when they are released for the exact line.
What to do before December 31
- Make sure every tip is reported. Unreported cash tips cannot be deducted. Keep a simple daily log and report it to your employer each month.
- Check your December pay stub. Confirm year-to-date tips and overtime look right before the W-2 is printed. Fixing it in January is harder.
- Adjust your withholding if you get a lot of overtime or tips. The Deductions Worksheet on Form W-4 lets you account for the deduction so less tax is held back through the year, instead of waiting for a refund.
- Watch the income limit if you are married. Two incomes can push a joint return past $300,000, which starts shrinking the deduction.
- Do not count on 2029. The deductions end after 2028 unless Congress extends them.
Getting it right on your return
Most errors we see are simple: overtime claimed at the full rate instead of the premium, automatic gratuities counted as tips, or married couples filing separately and losing the deduction entirely. Each one either costs money or invites an IRS letter.
London's Tax Services prepares federal and New York returns for restaurant, salon, hospitality, health care and warehouse workers from our office at 75 South Broadway in White Plains, serving Westchester County, the Bronx and New York City. We check your W-2 codes, apply the caps and income limits, and make sure the new New York tips exclusion shows up on your 2026 state return. Book a free 15-minute call or call (646) 917-7714.
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