Don’t believe hype on ‘no tax’ on tips, overtime, attorneys say

Listen to this article

By Kris Olson
BridgeTower Media

“Don’t believe the hype.”

That’s the main message employment attorneys offer after delving into the minutiae of the so-called “no tax on tips” and “no tax on overtime” provisions of the One Big Beautiful Bill Act, which President Trump signed into law on July 4.

While those provisions may have gotten the most media attention, they likely will not have the biggest impact on the widest range of businesses from the OBBBA, those lawyers add.

Overhyped though they may be, there are still nuances to learn, processes to adjust, strategies to consider, and pitfalls to avoid with the new deductions for overtime and tips, they say.

‘No tax’? Not really

The first thing that both employers and employees need to realize is that the slogans “no tax on tips” and “no tax on overtime” are misnomers in significant ways, attorneys agree.

Not only are there dollar limits on the new “above the line” deductions (meaning that the deduction is subtracted from an employee’s gross income to calculate their adjusted gross income), but in each case, the deduction applies only to “qualified” income.

What that means in the context of tips is that, to be eligible for the deduction, the employee must be working in an occupation that “customarily and regularly received tips” before the end of last year. The secretary of the Treasury is required to publish a list of the occupations the government will recognize as officially eligible by Oct. 2.

Already known is that employees in a “specified service trade or business,” a term of art in the Internal Revenue Code, will not qualify. Common SSTBs include health care, accounting, performing arts, athletics, investing and — yes, law.

In practice, attorneys expect the “no tax on tips” provision to apply almost exclusively to the service and hospitality industries.

There is an added wrinkle: To be eligible, the tips need to have been paid voluntarily. So, compulsory charges on banquet hall invoices or gratuities automatically added by restaurants to the bills of large parties would not qualify, though if a mandatory tip was 18 percent and the customer chose to give a larger tip, the deduction could still apply to the non-mandatory portion of the tip, noted Boston employment lawyer Sophie A. Levine.

Meanwhile, for overtime to be “qualified,” it must be overtime required under §7 of the Fair Labor Standards Act. The deduction then applies only to the portion of the pay that is more than the employee’s regular rate — in other words, just the “half” of “time and a half.” So, if an employee is earning $20 an hour and $30 an hour for overtime, the deduction is available only for the $10 an hour in premium pay.

Out in the world, there are other kinds of overtime. Certain states, for example, require employers to pay “same-day overtime” when an employee logs more than a certain number of hours in a day, or an employee may be entitled to overtime pay under the terms of a collective bargaining agreement.

“Employers might agree with a union to pay overtime after working more than 30 hours a week,” Levine explained. “Even though an employee might be getting paid overtime, since that’s not required by the FLSA, that overtime would not be subject to the deduction.”

To qualify for either deduction, married people must file jointly. The deductions also have caps. An employee can deduct up to $12,500 in overtime pay, or $25,000, if they are married and filing jointly. The limit on the tips deduction is $25,000, whether the employee is married or not.

In each case, if the employee’s adjusted gross income exceeds $150,000 (or $300,000 for married people filing jointly), the deduction starts to be whittled down, at a rate of $100 for each $1,000. So, a single employee with an adjusted gross income of $200,000 would have $5,000 lopped off their deduction.

“These things are called ‘no tax on overtime,’ ‘no tax on tips,’ and that sounds really great for workers,” said Boston lawyer Catherine E. Reuben. “But when you read the actual law, there are some things in it that make it a little less great and a little more administratively burdensome.”

Matthew Christoph, in-house counsel for a Waltham, Massachusetts-based company, agrees.

“There’s so much publicity about this law and the benefit to workers, and even the terminology — ‘no tax on tips’ and ‘no tax on overtime’ — is kind of a misnomer for what’s happening here,” he said.

Unless Congress extends them, the new deductions for tips and overtime will expire after the 2028 tax year.

Managing systems, expectations

The misleading nature of the “no tax on tips” and “no tax on overtime” slogans may create a challenge for employers to manage expectations, attorneys say.

As an initial matter, employees may believe that their paychecks will immediately reflect the impact of the new law. Instead, they will have to wait until they file next year’s tax returns to see any benefit, Christoph said.

“There’s no front-end benefit to workers around the law,” he said.

Moreover, especially with tips, many of the workers who might be eligible for the deduction have so little income, the deduction will not provide any meaningful benefit, Christoph noted.

Yale University’s Budget Lab found that 37% of tipped workers do not make enough money to pay any federal income taxes.

A recent story by Eyal Plant in the New Yorker titled “‘No Tax on Tips’ is an Industry Plant” notes that the new law will give large tax breaks to casino dealers earning six-figure salaries while leaving busboys out in the cold.

“It’s not as much of a powerhouse as it’s being presented as,” Christoph said.

From a policy perspective, the OBBBA disincentivizes state and federal governments from increasing the minimum wage, allowing them to point to the benefit of the tax deduction as an excuse not to do so, said Christoph, speaking in his personal capacity and not on behalf of his employer.

In a way, the new deduction works at cross purposes with state and federal overtime laws, as eligibility for premium pay was intended to disincentivize employers from requiring employees to work long hours, he noted.

“You’d like to see a broader approach, if possible, to help out American workers,” Christoph said.

To track and categorize overtime properly, some employers may need to retool their payroll systems, according to Reubens.

“For some employers, depending on their payroll system, this may be a logistical pain in the butt,” she said.

Christoph did not expect that to be a heavy lift, however.

“We are required by many states that we operate in to have overtime information on pay statements and on W-2s at the end of the year,” he said. “And for tipped employees, if you’re doing it right, you’re also including the tip amount.”

But Boston employment attorney Alexandra D. Thaler said that, in addition to ensuring that tips and overtime are being tracked properly, employers should be ready for questions that employees are likely to have when they see new lines and numbers on their pay stubs.

For example, the “half” portion of “time and a half” may now appear on its own line, and an employee may not immediately recognize that their compensation has not changed, just the details of how it is being reported.

“To the extent that employers aren’t used to having to answer that kind of question, or maybe they have some employees who are not as sophisticated and don’t immediately see that it’s literally the same thing, they should be aware enough of the reasons why they’re changing their reporting to be able to explain what it is that they’ve done,” she said.

No playing games

Given all the attention the new law has received, there may be some employers who are considering whether it makes sense to reclassify employees from exempt to non-exempt to make them eligible for the new overtime deduction, or whether they should reduce the hourly rates of their existing non-exempt employees and make up the difference by characterizing more of their hours as “overtime.”

But attorneys suspect employers would soon realize there is little point in expending too much energy on devising ways to game the system.

For example, because the overtime deduction applies only to actual, required FLSA overtime, “there’s not a loophole that can be found there,” Thaler said.

Tipped workers failing to report 100 percent of their gratuities as taxable income is a longstanding problem, and some have speculated that the OBBBA will prompt tips to be reported more reliably.

But Thaler wonders if it may instead have the opposite effect, given how deeply the misnomer “no tax on tips” has penetrated the public consciousness.

“Isn’t your first instinct, ‘If there’s no tax on tips, what does it matter what I took home in tips? I’m not going to be taxed on it, so why should I report it?’” she asked rhetorically. “I think that the unaware employee and employer may actually have more difficulty, if that’s where things go.”

A separate provision of the OBBBA has made beauty service businesses like barber shops, spas and nail studios newly eligible for a “tip credit” to reduce their taxable business income by the amount they pay for the employer share of the Social Security and Medicare taxes, also known as the FICA tax, on certain employee tips.

“I’m glad I’m not a tax preparer because I think there’s going to be a lot of confusion for those folks next year as to who gets what,” Thaler said.