Two provisions in the new tax law let workers keep more of their pay, and employers need to report them correctly.
Enacted last year, the Working Families Tax Cut Act gives small business owners and many employees significant tax savings. Most notable is the now-permanent 20% small business deduction. However, small business owners should be aware of two provisions in the law — “no tax on tips” and “no tax on overtime” — which allow workers to keep more of their paycheck.
“No tax on tips”
This new provision allows employees who “customarily and regularly received tips” to deduct up to $25,000 in tips from their taxable income so long as they include their Social Security number on their tax return.
Eligibility for tip deduction
This deduction is taken when an employee does their tax return. It is not reflected in regular paychecks. Only optional tips qualify for this deduction, not service charges automatically included in a bill. Not all occupations qualify for this deduction, and some jobs are excluded. The IRS has listed the occupations that are eligible.
What employers still must file
Not only does the “no tax on tips” provision reduce the tax burden on employees, but it also does not change the paperwork an employer must file. Business owners are still required to record and report the tips earned on an employee’s W-2 or a contractor’s 1099. Employers should refer to Notice 2025-69 from the IRS for guidance.
“No tax on overtime”
Previously, when an employee worked overtime and earned time-and-a-half pay, the entire portion of the additional income was subject to federal taxes. Now, with the new law, employees who work extra hours will be able to keep more of those hard-earned dollars.
How much overtime qualifies
The deduction applies to the amount “in excess of the regular rate,” which means only the extra pay accumulated during overtime is eligible. For example, if an employee earns $15 an hour regularly and $22.50 for overtime, the additional $7.50 is eligible for the deduction. Only overtime pay required under the Fair Labor Standards Act qualifies for the deduction. Employees cannot deduct tips they make while working overtime as overtime pay, though they can still deduct those tips under the “no tax on tips” deduction.
How to report overtime pay
As of August 2026, the IRS requires eligible overtime compensation to be reported on Form W-2 in Box 12 using code TT. Employers should report this properly to ensure their employees can claim the deduction. Employers should continue withholding federal income taxes and payroll taxes on overtime wages, as the deduction is claimed by employees on their individual tax returns.
Best practices
Small business owners should review the new IRS rules and communicate the changes to their employees. Employers should clarify that tips are not going “under the table,” and emphasize that “no tax on tips” is a deduction rather than an exemption, to ensure employees accurately report their tips. Employees should also know that only the difference between regular and overtime pay is eligible for the “no tax on overtime” deduction. The IRS periodically releases updated guidance on taxes. Keeping on top of these updates will allow businesses and employees to properly report income and maximize deductions.
