MW Tax breaks for tips and overtime pay are closer. Why some workers may still not be able to use them.

Andrew Keshner

Tax breaks on tips and overtime pay 'are in a very solid position to survive this bill process.' But that's not the end of the story.

Taxes for tipped workers and people getting overtime are starting to look a lot nicer.

After the House of Representatives passed a huge tax and spending bill Thursday, the major question is what will change once senators get their hands on the legislation.

The good news for certain workers is that the deductions for tips and overtime seem likely to stick around in the final bill, observers say.

The tax breaks on tips and overtime pay "are in a very solid position to survive this bill process," said Jennifer Acuña of KPMG. The Senate unexpectedly passed its own bill Tuesday giving a deduction on tips. "It has to be so popular to pass with such ease in the Senate," Acuña said.

But can all this momentum on tips and overtime translate into financial relief for workers on their tax returns and in their wallets?

One trouble spot could emerge in the fine print from lawmakers and regulators. Consumer mood is going to be a challenge too.

People who want to know if they qualify for the deductions will have to answer several questions: Is the pay a "qualified tip"? Is the worker a "highly compensated employee" who can't claim the break? And how will tip-fatigued customers respond, knowing workers are getting a break from the Internal Revenue Service?

There are already hints that people consider their waiter's financial situation when they decide how much to tip in a restaurant, said Michael Lynn, a professor at the Cornell Peter and Stephanie Nolan School of Hotel Administration.

Tax breaks for tips are popular with voters. But still, "there's a lot of dissatisfaction with tipping among consumers," Lynn said.

It's a reminder that there are hard questions ahead for workers and employers, even if it's smooth sailing on Capitol Hill.

What's a 'qualified tip' anyway?

President Donald Trump campaigned on promises of "no tax on tips" and "no tax on overtime." The Republican bill creates a temporary tax deduction lowering someone's taxable income when they have eligible tip and overtime pay.

The deduction lasts from 2025 to 2028. Workers can claim the breaks and also claim the widely-used standard deduction, which would also increase in the House bill.

The tip deduction could boost tipped workers' take-home pay by an average of $1,675, according to the White House's Council of Economic Advisors. Eligible overtime workers would get a tax cut between $1,400 and $1,750, the analysis said.

In the House version, the deduction is the same amount as the tipped pay or overtime reported on tax forms. The Senate version caps the tip deduction at $25,000 and has no expiration date.

One key question is how much tip income even gets reported on tax returns. Though 6 million tax returns reported $38 million in tipped income in 2018, the IRS has acknowledged there could be plenty of cash tips going unreported and untaxed.

The IRS currently says workers have to report their cash tips to their employer if the employee is making at least $20 per month in tips.

There's another rub: What counts as a tax-deductible "qualified tip"?

The answer is "any cash tip received by an individual in an occupation which traditionally and customarily received tips on or before Dec. 31, 2024," according to the Joint Committee on Taxation's explanation of the House bill.

It's up to the Treasury Department to make that distinction and have the IRS put it into practice.

At a time when shoppers see flip screens asking for a tip on all sorts of purchases, "we are changing every day the definition of who customarily gets tips," said Acuña. It may be an easy call for some jobs, like a waiter, but a gray area for other roles. Treasury Department officials "are going to have to be quite nimble," Acuña said.

A qualified tip is money received straight from a customer, "voluntarily paid and unrestricted in the amount," said Stephen Dombroski, senior payroll tax and financial compliance manager at Paychex $(PAYX)$. That could be a gratuity paid through cash, credit cards, debit cards or other electronic payments, he said.

The Treasury Department list of who qualifies is still a ways away, but Dombroski took a shot at who would be included. It's common for food servers, bartenders, hairstylists, taxi drivers and delivery drivers to receive what's considered a qualified tip, he said.

Who can claim the deductions for tips and overtime pay?

The House bill has a couple of requirements. People claiming the deductions need to have a Social Security number. If they are married, their spouse must have a valid number too.

The tax breaks are aimed at lower- and middle-income households, particularly for people with tip income. Someone claiming the deductions cannot be a "highly compensated employee" in the eyes of the IRS. Under 2025 rules, that means someone making $160,000 or above in their compensation.

The $160,000 cap rises with inflation. It may not thwart many people with a tip deduction, but it could be something people with eligible overtime pay need to consider, Jeff Martin, a partner in Grant Thornton's Washington National Tax Office, previously told MarketWatch.

The overtime has to be eligible under the Fair Labor Standards Act. This could include jobs like nursing and construction, but not jobs like lawyers or doctors.

Many workers don't know their employer counts them as "highly compensated" for tax purposes, he said. If they are withholding more on their paycheck and banking on a deduction they don't receive, that could set them up for an IRS penalty paying too little tax.

It's going to be important that employers and workers communicate, he said.

Will people tip less?

It's reasonable to think consumers might tip less if they think someone's getting a deduction on their tips, said Lynn. If the tip tax deduction becomes law, it will be an experiment on a national scale to see how consumers react.

States and the federal government have a minimum wage and also a tipped minimum wage that's usually lower. The federal minimum wage is $7.25 per hour and the federal tipped minimum is $2.13.

Critics of "no tax on tips" say a better way to help tipped workers is raising tipped minimum wages.

Tips tend to be a bigger percentage of a diner's bill in states where tipped minimum wages are lower, Lynn said. "The data suggests that people do tip in part to make up for low wages and, indeed, if you ask, many people will tell you that's the reason they tip."

-Andrew Keshner

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May 23, 2025 07:15 ET (11:15 GMT)

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