IRS Explains How US Workers Can Claim Trump's Tips, Overtime Deductions For 2025 Tax Year With Actual Use Cases

As the 2025 tax season approaches, the Internal Revenue Service (IRS) and the US Treasury Department have released guidance on claiming new federal deductions, enacted under President Donald Trump's 'One Big Beautiful Bill.' This legislation allows eligible workers to deduct cash tips and overtime pay, with the IRS providing detailed instructions and practical examples.

The guidance, issued late last week, explains how workers can determine their deductions without receiving separate accounting from their employers for cash tips and qualified overtime income. This clarification aims to streamline the process, especially since information returns such as forms W-2 and 1099 may not always separately report tips or overtime pay.

The IRS is currently updating income tax forms and instructions to facilitate these claims for the upcoming filing season, ensuring taxpayers can benefit from the new deductions.

No Tax on Tips — But There Are Limits

The legislation permits eligible workers to claim a maximum annual deduction of up to $25,000 on qualified tips for tax years 2025 through 2028. However, the benefit gradually phases out for taxpayers with a modified adjusted gross income (MAGI) exceeding $150,000 (£113,766) or $300,000 (£227,533) for joint filers.

Example 1:
A restaurant server reports $18,000 (£13,652) in tips on their 2025 Form W-2 but did not report additional tips on Form 4137. In this case, they can use the $18,000 to determine their qualified tips for that tax year.

Example 2:
A self-employed sole proprietor receives $7,000 (£5,309) in tips via a third-party settlement organisation (TPSO). The 1099-K from the TPSO shows $55,000 (£41,714) in total payments, but tips aren't separately identified. If the individual records each tip received, the $7,000 can be used to determine their qualified tips for 2025.

Tax Break on Overtime Income

The bill also provides a tax deduction for eligible overtime pay. Workers can deduct qualified overtime pay that exceeds their regular rate, up to $12,500 (£9,480) annually — or $25,000 (£18,961) for joint filers.

Similar to tips, this benefit phases out for taxpayers with MAGI above $150,000 or $300,000 for joint filers. The deduction is available regardless of whether taxpayers itemise or not.

Example:
A worker receives a payroll statement indicating $5,000 (£3,792) as overtime pay in 2025. They can include this amount to determine their qualified overtime income.

Another scenario:
If an employee is paid double their regular rate for overtime, say $20,000 (£15,168), they can divide this amount by 4, resulting in $5,000 for the deduction.

Additional example:
If an employee receives one and a half times their regular rate for overtime, the IRS suggests including one-third of the overtime income in the deduction calculation.

Caution and Future Implications

While these tax breaks are expected to put more money in workers' pockets over the coming years, experts warn that claims could be scrutinised during tax return processing. Workers should ensure accurate record-keeping to substantiate their deductions.

The IRS's guidance aims to clarify how eligible workers can maximise these benefits, but taxpayers are advised to consult with tax professionals if they have questions.

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