Compliance
Navigating the New Deduction for Overtime & Tips Under the One, Big, Beautiful Bill
Millions of service and hourly workers now have relief from federal tax on certain overtime and tip earnings—here’s how to make sure you benefit fully this season.
By NomadicTax Research Team • 5-8 min read • February 23, 2026
## What Has Changed
The One, Big, Beautiful Bill provides a **new deduction** for “qualified overtime compensation” and tips beginning in **tax year 2025**.([irs.gov](https://www.irs.gov/newsroom/news-releases-for-december-2025?utm_source=openai)) This means many workers who receive tips or overtime may reduce their taxable income via this deduction.
## Who Is Eligible
- Hourly or service employees who earn tips or overtime pay.
- You must have valid wages or tips documented on your W-2 and Form 1099 (where applicable).
- Not applicable for certain exempt or salaried workers whose pay does not qualify as “qualified overtime compensation” or “tips” under IRS definitions.
## How the Deduction Works
- **Qualified Overtime Compensation** includes pay for hours worked beyond the standard full-time threshold (e.g., over 40 hours/week). Specific definitions may vary—consult the IRS Fact Sheet 2026-01 for rules.([irs.gov](https://www.irs.gov/newsroom/news-releases-for-january-2026?utm_source=openai))
- “Tips” refers to amounts received directly or via tip‐sharing, as long as reported properly.
- The deduction reduces your adjusted gross income (AGI), which also lowers exposure to various phase-outs and AMT adjustments.
## Practical Example
> Maria works 45 hours weekly at a restaurant and earns $300/week in tips. Suppose her regular wages are $15/hr; her overtime (5 extra hours at time-and-a-half) is $37.50/week. Under the new deduction, she can reduce her taxable income by the amount of overtime and tips that qualify, lowering her overall tax liability.
## Steps to Claim the Deduction
1. Gather all documentation: W-2, 1099s including any that report tips or third-party payments.
2. Use the IRS’s updated information and worksheets in Fact Sheet 2026-01 to identify qualifying amounts.([irs.gov](https://www.irs.gov/newsroom/prepare-to-file-in-2026-get-ready-for-tax-season-with-key-updates-essential-tips?utm_source=openai))
3. On your Form 1040, report wages, tips, etc., and subtract the qualified overtime and tips from AGI per the instructions.
## Issues, Caveats & Compliance Risks
- Underreporting tips remains a serious issue. Only reported tips with proof are eligible. Using IRS tools like Tip Rate Determination Agreements or employer statements can help.
- Overclaiming overtime compensation without clear records may trigger audits—hours logged, pay rates, and actual hours matter.
- Recently issued FAQs—per the IRS—offer guidance, but detailed regulation may still evolve. Keep an eye on upcoming regulations.([irs.gov](https://www.irs.gov/newsroom/news-releases-for-january-2026?utm_source=openai))
This deduction is a big win for many wage-earning Americans—especially in service, hospitality, and retail sectors. If you earn tips or overtime, it’s essential to calculate whether this new relief reduces your taxable income significantly—and to document everything precisely.