What the New IRS Tips and Overtime Rules Mean for Your Taxes

On August 6, 2026, the IRS updated its FAQs on the overtime deduction, and in April it issued final regulations on the tipped-occupation list. For you, the practical change is this: on 2026 income, overtime counts only if your employer reports it on the W-2, and tips must appear on a W-2, a 1099 or your own Form 4137; the 2025 estimating shortcuts no longer apply. Both cut federal income tax only; payroll taxes are unchanged.

Key takeaways

The tips deduction is capped at $25,000 per return and the overtime deduction at $12,500 ($25,000 on a joint return), for tax years 2025 through 2028.
Only the "half" in time-and-a-half that the Fair Labor Standards Act (FLSA) requires counts as qualified overtime, not the whole overtime paycheck.
Both deductions shrink by $100 for every full $1,000 of modified adjusted gross income above $150,000 ($300,000 joint). Both require a Social Security number valid for employment and, for married people, a joint return.
You can claim them whether or not you itemize, but they reduce income tax only; Social Security and Medicare taxes still apply.
For 2026 income, overtime not shown in W-2 box 12, code TT cannot be deducted. Tips can also be claimed from a 1099 or Form 4137.

What it means for you

Servers and bartenders: your tips qualify if they are voluntary, cash or charged, and earned in an occupation on the IRS tipped-occupation list.
Hourly workers with overtime: for most employees, only the FLSA-required premium for hours over 40 in a workweek qualifies.
Exempt workers: if you are exempt from FLSA overtime, the deduction does not apply, even if your employer pays extra for long hours.
Gig and self-employed workers who get tips: you can qualify if your occupation is on the list, but the deduction cannot exceed net income from that activity.
Married couples: married filing separately gets neither deduction.
Higher earners: check modified adjusted gross income against $150,000 (single) or $300,000 (joint).

Who qualifies for the tip deduction

The deduction is for "qualified tips," defined in 26 U.S.C. 224 as cash tips (including charged tips and, for employees, tip-pool shares) received in an occupation that customarily and regularly received tips on or before December 31, 2024. The tip must be paid voluntarily with no consequence for not paying, must not be negotiated, and its amount must be decided by the customer who pays it.

The final regulations (IR-2026-49, April 10, 2026; Federal Register, April 13, 2026) list more than 70 occupations in eight categories and apply from the 2025 tax year.

Conditions that catch people out

Reporting: the tips must appear on a Form W-2, 1099-NEC, 1099-MISC or 1099-K, or be reported by you on Form 4137 (tips you did not report to your employer).
Social Security number and filing status: the spouse who received the tips needs a Social Security number valid for employment, and married taxpayers must file jointly. The number must be issued before the return's due date, including extensions; the final tip regulations and the IRS overtime FAQs both say so.
Specified service trades: by statute, tips earned in a specified service trade or business under section 199A are excluded; for employees, the employer's business decides it. Notice 2025-69 suspends this test for anyone in a listed occupation until January 1 of the year after final regulations on it are issued. The April 2026 final rules left that topic reserved, so the relief still applies.
Self-employed limit: the deduction cannot exceed net income from the business in which the tips were earned, figured without the deduction.

How the overtime deduction works

Qualified overtime compensation is overtime pay required by section 7 of the FLSA that exceeds the employee's regular rate. As the IRS explains in its August 2026 overtime FAQs (FS-2026-13), only FLSA overtime-eligible employees get it, and overtime that is required only by a union contract, state law or an employer's own policy does not count unless the FLSA also requires it.

For most employees, the FAQs give this weekly formula:

Qualified overtime = FLSA hours over 40 in the workweek x 0.5 x FLSA regular rate

Each workweek stands alone, so hours cannot be averaged across weeks. If an employer pays double time, only the one-half premium the FLSA minimally requires counts. For most employees, premiums for hours beyond eight in a day or 35 in a week count only to the extent the FLSA itself requires them. Employees of hospitals and certain residential care facilities, public fire and police employees, and state or local government workers who get comp time can fall under other FLSA methods; for them, the premium actually paid under that method counts.

Common FLSA exemptions listed in the FAQs include executive, administrative and professional employees, outside sales employees and certain computer-related occupations. An employee who owns at least 20% of the business and actively manages it is generally exempt. Each exemption has its own specific tests, so being salaried alone does not settle it; ask your payroll team.

Limits, phase-out and examples

Both deductions are reduced, but not below zero, by $100 for each $1,000 that modified adjusted gross income (MAGI) exceeds $150,000, or $300,000 on a joint return (26 U.S.C. 225). Schedule 1-A drops any partial $1,000, so MAGI of $320,500 on a joint return gives the same $2,000 reduction as $320,000. Because these deductions are taken after adjusted gross income, they do not lower MAGI. The $25,000 tips cap is per return, even if both spouses earn tips.

Deduction	Cap	Phase-out starts above	Deduction hits $0 at (full-cap claim)
Tips, single	$25,000	$150,000	$400,000
Tips, joint	$25,000	$300,000	$550,000
Overtime, single	$12,500	$150,000	$275,000
Overtime, joint	$25,000	$300,000	$550,000

The last column is arithmetic (cap divided by $100, times $1,000, plus the threshold); a smaller claim reaches $0 sooner.

Illustrative example A: a server

A single server has $18,000 of qualified tips and $48,000 of MAGI. Both are under the limits, so the deduction is $18,000. At an assumed 12% marginal federal rate, income tax falls by about $2,160 (18,000 x 0.12).

Illustrative example B: an hourly worker

A worker with a $24 regular rate works 200 FLSA overtime hours in the year at time-and-a-half. Overtime pay is 200 x $36 = $7,200, but the premium is 200 x $12 = $2,400, and only that is deductible. At 12%, the saving is about $288; at 22%, about $528.

Illustrative example C: a joint filer in the phase-out

A married couple filing jointly has MAGI of $320,000 and $20,000 of qualified tips. MAGI is $20,000 over $300,000, so the reduction is 20 x $100 = $2,000, leaving an $18,000 deduction instead of $20,000.

Reporting: 2025 vs 2026 returns

For 2025, the W-2 was unchanged, so Notice 2025-69 let workers estimate: for tips, by using W-2 box 7 social security tips, tips reported to the employer on Forms 4070, or an amount an employer chose to report in box 14. Both deductions go on Schedule 1-A (Form 1040), which flows to line 13b of the 2025 Form 1040 (line 13a on the 2026 draft).

For 2026, the 2026 W-2 instructions add box 12 code TP (all cash tips reported to the employer, not only qualified tips), box 14b (the Treasury Tipped Occupation Code) and box 12 code TT (qualified overtime). Employers must furnish 2026 W-2s by February 1, 2027. The overtime FAQs say there is no relief after 2025: only overtime in box 12, code TT can be deducted, and a substitute W-2 (Form 4852) does not count.

Code TT shows total qualified overtime paid, even above the cap; the FAQ example has $30,000 on the W-2 and a $12,500 limit. You enter the W-2 amount on Schedule 1-A, and the form applies the cap and phase-out. If the employer overstated code TT, only the overtime actually paid counts.

Adjusting withholding

The overtime FAQs say employers may not reduce withholding for the deduction unless you give them an updated Form W-4. The 2026 Form W-4 Step 4(b) worksheet has line 1a for estimated qualified tips (up to $25,000) and line 1b for overtime (up to $12,500, or $25,000 joint) if total income is under $150,000 ($300,000 joint). The IRS Tax Withholding Estimator also accounts for the overtime deduction. Otherwise the saving arrives at filing.

State taxes

State treatment varies. In a May 28, 2026 count, Ballotpedia found 19 of the 41 states with a broad wage income tax had conformed to the tips deduction, 21 had not and Georgia had partly conformed. That count covers tips only. Check your state revenue department for both deductions.

Frequently asked questions

Are Social Security and Medicare tax still due on tips and overtime?

Yes. The IRS says overtime pay is generally not excluded from wages for employment taxes, and the W-2 instructions say tips are generally subject to income tax withholding and Social Security and Medicare tax when they reach $20 or more in a month.

Must you itemize to claim either deduction?

No. The IRS says both are available with the standard deduction or itemizing; see its Working Families Tax Cuts page.

Is double-time or union overtime pay fully deductible?

No. If an employer pays more than the FLSA requires, only the minimum premium the FLSA requires counts. In the IRS example, a worker paid $20 an hour works 50 hours and gets double time for the 10 overtime hours: that is $200 of premium, but only $100 is qualified overtime.

What if my employer left overtime off my 2026 W-2 or understated it?

Ask the employer for a corrected Form W-2c, which the IRS says employers must issue when they find a code TT error. If the employer cannot or will not provide one, you can use only the amount shown in box 12, code TT, even if you were paid more.

Does an automatic service charge count as a tip?

Generally not. The IRS release says a service charge counts only if the customer can disregard or modify it; its example is an automatic 18% large-party charge, which is not a qualified tip even when shared with staff.

Steps to take before filing

Confirm your job is on the tipped-occupation list, or that you are FLSA overtime-eligible.
Check your Social Security number is valid for employment and your filing status is not married filing separately.
Estimate MAGI against $150,000 ($300,000 joint) to see if the phase-out applies.
When your 2026 W-2 arrives (due by February 1, 2027), look for box 12 code TP, box 14b and box 12 code TT. If an overtime figure is missing or wrong, ask for a W-2c.
Keep tip logs, Forms 4070 or 4137 and pay stubs showing overtime hours.
Consider a new W-4 if you want the saving in paychecks now.

This article is general education, not tax advice; rules and forms can change, and individual situations vary.