The 2026 tips and overtime deductions, explained

How the two deductions work

The 2025 tax law (Public Law 119-21) created two new federal deductions for tax years 2025 through 2028: one for qualified tips and one for qualified overtime compensation. You claim them on Schedule 1-A of Form 1040. They are subtracted after adjusted gross income, alongside the standard or itemized deduction, so you get them either way.

Because they do not lower adjusted gross income, they leave AGI-based figures such as the earned income credit unchanged. They lower taxable income, so the tax saved is roughly the deduction times your top bracket: 12% for many tipped workers, 22% or 24% for many people working overtime.

The tips and overtime are still included in your wages. Nothing changes on your paycheck except, possibly, how much income tax is withheld.

What counts as qualified tips

• Voluntary tips, paid in cash or charged to a card, including tips received through a tip-sharing arrangement. Because tips must be voluntary, a service charge added automatically to a bill does not count.
• In an eligible occupation: one on the IRS list of occupations that customarily and regularly received tips on or before December 31, 2024, such as servers, bartenders, hairstylists and delivery drivers.
• Reported: on a Form W-2, a Form 1099, or Form 4137 for tips you report yourself.

Self-employed people in a specified service trade or business (fields such as health, law and performing arts) cannot claim it, nor can employees of such a business, and a self-employed person's deduction cannot exceed the net income of the business where the tips were earned.

What counts as qualified overtime

Only the premium portion of overtime the federal Fair Labor Standards Act (FLSA) requires: in time-and-a-half, the "half". The IRS describes it as pay required under section 7 of the FLSA that is more than your regular rate. Your base pay for the overtime hours is not deductible. Overtime paid only because of a state law or a union contract, beyond what the FLSA requires, does not count; neither does overtime paid to workers the FLSA exempts from its overtime rules, such as many salaried managers.

Who can claim them

• You (or your spouse, if the spouse received the tips or overtime) need a valid Social Security number.
• Married couples must file jointly. Married filing separately gets neither deduction.
• The tips limit is $25,000 per return, joint or not. The overtime limit is $12,500, or $25,000 on a joint return.
• Both phase out above $150,000 of modified AGI ($300,000 joint) by $100 per full $1,000, a 10% rate. A full overtime deduction is gone at $275,000 single; a full tips deduction at $400,000 single or $550,000 joint.

Single filer with $12,500 of overtime premium and wages only, so modified AGI equals wages.

How much they save

Federal income tax for 2026, figured with and without the deduction, for wage earners taking the standard deduction:

Wages include the tips or overtime. Federal income tax only; Social Security and Medicare still apply to the full amount.

The server's $1,800 is 12% of $15,000. The bartender received $32,000 of tips but can deduct only $25,000, and part of that deduction comes out of the 12% bracket rather than the 22% top bracket. The couple, with one spouse earning $20,000 of overtime premium, is in the phase-out and keeps an $18,800 deduction, worth $4,512 at the 24% bracket.

Payroll taxes and your W-2

These are income tax deductions only. Tips and overtime are still subject to Social Security (6.2%) and Medicare (1.45%) taxes, so the server above still pays $1,148 of payroll tax on those tips. Employers keep withholding income tax on them as on other wages, unless you adjust your W-4 to account for the deduction.

For 2026, employers report cash tips in box 12 of Form W-2 with code TP, along with a Treasury tipped occupation code, and qualified overtime with code TT. For 2025 the IRS gave employers and workers transition relief from the new reporting rules.

Which states follow

States decide for themselves. Of the 41 states plus DC that tax wages, 12 give some break for tips or overtime in 2026; the other 30 tax them in full. The 9 states with no income tax on wages do not tax them at all. State tax saved, from each state's 2026 return:

Server: single, $45,000 of wages with $15,000 of tips. Nurse: single, $90,000 with $8,000 of overtime premium. State income tax only. A $0 can mean the income is already below the state's taxable threshold.

States that start from federal adjusted gross income, such as California and Illinois, miss the deductions automatically because they come after AGI, unless they pass their own: New York added a subtraction for tips (not overtime) starting in 2026. Others have said so explicitly: Rhode Island, for example, has announced it will not allow these exclusions. In Alabama and Missouri, which let you deduct part of your federal income tax, the lower federal bill slightly raises state tax: by about $90 and $21 for the server.

Several of these rules are new and some 2026 state forms are not yet out, so treat the state figures as estimates. Our paycheck calculator shows payroll taxes on tips and overtime, and the 2026 tax brackets guide explains how a deduction translates into tax saved.