For tax year 2025, the Internal Revenue Service (IRS) has introduced a temporary deduction for certain workers receiving qualified tips and overtime pay, providing much-needed tax relief to hourly employees, service industry workers, and those earning extra through overtime. This deduction applies to income earned in 2025, filed during the 2026 tax season.

🧾 What Is the Worker Income Deduction?

Traditionally, all tips and overtime pay are included in gross income for federal income tax purposes. The new temporary Worker Income Deduction allows qualifying taxpayers to exclude a portion of their qualified tips and overtime pay from federal taxable income. This provision is designed to:

• Reduce tax liability for workers who rely on tips or overtime earnings.
• Help employees keep more of their income during high-inflation periods.
• Encourage compliance and accurate reporting of tips and overtime.

✅ Eligibility Criteria

To claim this deduction, workers must meet the following requirements:

1. Employment Type: Must be employed in service-related roles or positions that earn tips as part of regular compensation.
2. Overtime and Tips: The deduction applies only to income earned from overtime work or qualified tips reported to the employer.
3. Temporary Measure: This provision is available for the 2025 tax year only, unless extended by Congress.

💰 How It Works

• The IRS allows eligible taxpayers to subtract a specific portion of their qualified tips and overtime pay from taxable income.
• The exact calculation is based on reported tips and hours of overtime worked. Employees should carefully track both for accurate tax reporting.
• Workers can claim the deduction even if they use the standard deduction, similar to other above-the-line deductions.

📊 Example

Suppose a waiter earns $5,000 in tips during 2025 and $2,000 in overtime pay. Under the temporary deduction:

• A portion of this $7,000 combined income can be excluded from taxable income.
• This reduces federal taxable income, lowering the overall tax bill or increasing the refund.

🧠 Planning Tips

• Keep accurate records of all tips and overtime earnings.
• Coordinate with payroll to ensure proper reporting to the IRS.
• Consult a tax professional to maximize benefits and ensure compliance with IRS rules.

📌 Why This Matters

This temporary deduction provides meaningful relief to workers whose income includes tips or overtime. By reducing taxable income, it helps improve take-home pay and ensures workers are not unfairly taxed on earned compensation during high-demand periods.