New Tax Deductions for Tips, Overtime, and Seniors: Key Changes from the One Big Beautiful Bill (OB3)

The enactment of the One Big Beautiful Bill Act (OB3) in Public Law 119-21, Sec. 70114, on July 4, 2025, introduced targeted tax deductions for workers and retirees, including new deductions for tips, overtime pay, and senior taxpayers which will be available for tax years 2025 through 2028. This article provides an overview of the changes, including who qualifies, how the deductions work, and a demonstration of real-life examples.

Tax Related Key Terms to Know

Adjusted Gross Income (AGI):

Your total taxable income before claiming either the standard deduction or itemized deductions. Think of AGI as the baseline number the IRS starts with when determining how much tax you owe.

Modified Adjusted Gross Income (MAGI):

AGI with certain amounts added back in—most commonly tax‑exempt interest and excluded foreign income. OB3’s phase‑out rules use MAGI, not AGI, to decide whether your deduction is reduced.

Above‑the‑Line Deduction:

A deduction taken on the front page of Form 1040 that lowers AGI. Because it reduces AGI, it can also make you eligible for other tax breaks tied to income levels.

Below‑the‑Line Deduction:

A deduction taken after AGI is calculated (usually on Schedule A or the line right before taxable income). It reduces taxable income but does not change AGI, so it won’t affect income‑based limits for other credits and deductions.

Phase‑Out:

A gradual reduction of a tax benefit once income rises above a set threshold. Under OB3, you lose $100 of certain deductions for every $1,000 your MAGI exceeds the specified limit until the benefit reaches zero.

New Rules for Tipped Income

What is a Tip?

Tip income refers to discretionary money that customers give to employees for service. Tips are considered taxable income, regardless of whether they are received in cash, electronically, or as non-cash gifts (such as concert tickets).

Examples of tip income include:

-       Cash tips given directly by customers.

-       Credit or debit card tips distributed by the employer.

-       Tips shared among employees through a tip pool or tip-splitting arrangement.

-       Non-cash tips (e.g., tickets or gift cards), which are valued at fair market value.

What Type of Tips Are Included?

Qualified tips are defined by the IRS as voluntary cash or charged tips received from customers or through tip sharing. The word voluntary is important to note, as mandatory service charges or automatic gratuity are, under current guidance, not considered qualified tips and cannot be included in this deduction.

How are Tips Reported for Employees?

By law, a worker who receives tips is required to report all tips to their employer if they total $20 or more in a month. The employer includes these tips in the worker’s paycheck, withholding all applicable taxes. When the worker receives their W-2, the reported tips are included and added to their other income to determine their tax liability.

The New Deduction

Under OB3, eligible workers now have an above-the-line deduction (meaning it’s available regardless of whether a taxpayer itemizes deductions) of up to $25,000 in reported tip income for tax years 2025-2028. However, the worker must be employed in a qualifying tipped occupation – think servers, bartenders, hairstylists, and nail techs. Note: The deduction isn’t available if you (or your employer) are in a ‘Specified Service Trade or Business’—think law, accounting, consulting, health, etc.—as defined in §199A.

The U.S. Treasury Department and IRS will publish guidance by October 2^nd, 2025, specifying which jobs will be eligible for this deduction so you’ll need to stay tuned for additional information.

Phase-out Rules

In addition, an income phaseout also applies to this deduction (this means that if you make too much money, you are not eligible). The amount allowed as a deduction (after application of the $25,000 limit) is reduced, but not below $0, by $100 for each $1,000 that the taxpayer’s Modified AGI (MAGI) exceeds $150,000 (or $300,000 on a joint return).

Tips for Self-Employed Individuals

For self-employed individuals who receive tips through their normal course of business, the deduction may not exceed the individual’s net income from the trade or business in which the tips were earned. If the business incurs a net loss for the year, then no tip income would be deductible.

As an example, in 2025, assume that Hairstylist Hailey, who owns and operates her own salon, posts net income on her year end income statement of $18,000 and tip income of $21,500. Hailey is married to Regular Robert and together, their AGI on a joint return is $325,600.

The tips deduction only considers $18,000 of the tips due to the net income limitation of the business. Because their AGI is above the $300,000 phaseout range, we need to determine how much of the deduction to phase out. Their AGI exceeds the threshold by $25,000 so Hailey’s tips deduction will be reduced by 25 x $100 = $2,500. This will reduce her tips deduction from $18,000 down to $15,500.

New Overtime Tax Deduction

What is Overtime Pay?

Overtime pay refers to compensation earned by employees for working more than their standard hours, typically calculated at a higher rate—commonly referred to as “time-and-a-half.” Under OB3, the portion of overtime pay that exceeds an employee’s regular hourly rate (i.e., the “half” in “time-and-a-half”) may now qualify for a special tax deduction.

What Type of Overtime Pay is Included?

Qualified overtime compensation must be reported on a Form W-2, Form 1099, or another official wage statement. Only the excess amount above the employee’s regular rate is considered eligible for the deduction. For example, if an employee’s standard wage is $30/hour and they are paid $45/hour for overtime, the deductible amount is the $15/hour difference.

How is Overtime Pay Reported for Tax Purposes?

For tax years 2025-2028, qualifying individuals can claim an above-the-line deduction of up to $12,500 for single filers or $25,000 for joint filers based on eligible overtime earnings. This deduction is available regardless of whether the taxpayer itemizes deductions and reduces taxable income directly on the front of the tax return.

Phase-out Rules

Like the tip income deduction, the overtime deduction phases out for higher-income taxpayers. The amount of the deduction is reduced—but not below zero—by $100 for every $1,000 that a taxpayer’s Modified Adjusted Gross Income (MAGI) exceeds $150,000 for single filers or $300,000 for joint filers.

As an example, Electrician Eric works as an hourly employee where he earns overtime regularly. He is single and has MAGI of $63,200. His normal rate of pay is $30 per hour, and his overtime rate of pay is $45 per hour. The $15 difference between Eric’s regular rate of pay and his overtime rate of pay is the deductible portion under the new law.

If Eric works 255 hours of overtime in 2025, then his overtime tax deduction would be calculated as follows: 255 hours X $15 = $3,825.

Because Eric’s MAGI is under $150,000, the full amount of $3,825 in overtime pay that Eric earned in 2025 would be applied as an above-the-line deduction on his personal income tax return, meaning he can take this deduction regardless of whether he itemizes his deductions.

New Senior Deduction

What is the Senior Deduction?

For tax years 2025-2028, a new tax deduction is available to individuals aged 65 and older. This $6,000 deduction is designed to provide targeted relief for seniors and is claimed as a below-the-line deduction, meaning it reduces taxable income but does not affect Adjusted Gross Income (AGI). It is not considered an itemized deduction, so taxpayers can claim it even if they take the standard deduction.

If both spouses are 65 or older, you can double the deduction—to $12,000.

It’s important to note that eligibility for the senior deduction is based on age—not whether the taxpayer receives Social Security benefits.

Who Qualifies?

To claim the deduction, the taxpayer must be 65 years or older by the end of the tax year. On a joint return, only one spouse needs to meet the age requirement in order to qualify for a single $6,000 deduction. This makes it particularly beneficial for couples with one senior spouse.

Phase-out Rules

The senior deduction begins to phase out once a taxpayer’s Modified Adjusted Gross Income (MAGI) exceeds $75,000 (or $150,000 on a joint return). The deduction is reduced by 6% of the amount by which MAGI exceeds the applicable threshold, but never reduced below zero.

As an example, consider Twilight Tom, aged 67, and Jubilant Janice, aged 61. They file a joint return in 2025 with MAGI of $185,000. Because Tom is over 65, they qualify for the senior deduction. However, their MAGI exceeds the $150,000 threshold by $35,000, so we apply the 6% phaseout:

6% of $35,000 = $2,100

$6,000 – $2,100 = $3,900 allowable deduction

As a result, Tom and Janice can claim a $3,900 senior deduction on their 2025 tax return.

Conclusion

The recent changes introduced by the One Big Beautiful Bill may make it more challenging to understand your individual tax situation. It’s important for individuals to consult with a qualified tax professional to ensure they’re compliant with current tax laws and able to optimize their tax position. If you need help navigating the nuances of the One Big Beautiful Bill, Contact Parks Tax & Consulting PLLC for expert guidance tailored to your unique situation.

This post may not contain a complete analysis of the tax issues discussed herein and does not represent official conclusions or advice regarding the matter.