The One Big Beautiful Bill Act (OBBBA) created two above-the-line federal income tax deductions effective 2025–2028: qualified tip income (up to $25,000/year) and the FLSA overtime premium (up to $12,500/year). Tips and overtime remain subject to FICA, FUTA, and any state taxes that otherwise apply: this is a deduction employees claim at tax time, not a payroll tax exemption. For Maine employers, the obligation is tracking these amounts separately so employees can document what they've earned.
Whether you run a restaurant in Maine, manage a hotel, operate a construction crew, or employ any hourly workforce, your tipped and overtime-eligible employees are counting on you for the documentation they need to claim these deductions. Here's what you need to know, and what you need to do before the 2026 mandatory reporting deadline.
1. What Changed: The OBBBA in Plain English
The One Big Beautiful Bill Act, signed into law in 2025, introduced two above-the-line deductions for tipped workers and FLSA non-exempt hourly employees. Employees claim these on Form 1040 when they file. You do not change how you figure FICA or FUTA. Employees who expect to claim these deductions can reflect them on the 2026 Form W-4 Deductions Worksheet (Step 4(b)), which lowers their federal income tax withholding. What you do need to do is track these amounts cleanly, because employees can only deduct what they can document.
2. No Tax on Tips: What Qualifies
Employees may deduct up to $25,000 of qualified tip income per year from federal taxable income for tax years 2025–2028.
What Counts as a Qualified Tip
- Voluntary payments from customers: the customer decides whether to tip and how much
- Cash tips, credit card tips, and legitimate tip pool distributions
- Earned in an occupation that customarily and regularly received tips on or before December 31, 2024
- Reported on a Form W-2, Form 1099, another statement furnished to the worker, or on Form 4137
What Does NOT Qualify
- Mandatory service charges: automatic gratuities the customer cannot modify are classified as wages, not tips
- Tips received in a Specified Service Trade or Business (SSTB) such as financial services, including tips received by employees of an SSTB employer
- Employees filing married filing separately are not eligible
| Filing Status | Max Deduction | Phase-Out Begins (MAGI) |
|---|---|---|
| Single / HOH | $25,000 | > $150,000 |
| Married Filing Jointly | $25,000 | > $300,000 |
| Married Filing Separately | Not eligible | N/A |
3. No Tax on Overtime: What Qualifies
The overtime deduction covers only the premium portion of FLSA-required overtime (the "half" in "time-and-a-half").
- Only FLSA non-exempt employees qualify: the overtime must be required by the FLSA's weekly 40-hour threshold
- Salaried exempt employees (executive, administrative, professional, outside sales) do not qualify, even if paid overtime voluntarily
- If the employer pays double-time instead of time-and-a-half, only the FLSA-required half counts
- Available for both itemizing and non-itemizing taxpayers
| Filing Status | Max Deduction | Phase-Out Begins (MAGI) |
|---|---|---|
| Single / HOH | $12,500 | > $150,000 |
| Married Filing Jointly | $25,000 | > $300,000 |
4. W-2 Reporting: 2025 vs. 2026 Requirements
2025: Transition Year (No Penalties)
Under IRS transition relief for the 2025 tax year, employers will not face penalties for failing to separately report tips or OT premium on 2025 W-2s, as long as aggregate wages are correctly reported. The IRS also confirmed that 2025 W-2 and 1099 forms will not be updated with dedicated boxes for these amounts yet.
Employers are strongly encouraged to voluntarily provide this data because your employees need it to claim their deductions:
- Report qualified OT premium in Box 14 of Form W-2 (label: "Qualified OT" or "FLSA OT Premium")
- Provide tipped employees a year-end statement with their occupation code and annual tip total
| Tax Year 2025 | Tax Year 2026+ | |
|---|---|---|
| Separate OT premium on W-2 | Voluntary (encouraged) | Mandatory (box 12, code TT) |
| Tip amount + occupation on W-2 | Voluntary (encouraged) | Mandatory (box 12, code TP; occupation code in box 14b) |
| Penalties for non-reporting | Waived for 2025 | $60+ per form |
5. Maine-Specific Considerations
The OBBBA is federal law and applies the same way in every state. But how it interacts with Maine's tax code, minimum wage structure, and overtime rules affects how you communicate this to employees and how you configure your payroll system.
State Income Tax Treatment Varies
The OBBBA deduction is federal only. Whether Maine taxes tip and overtime income the same as other wages depends on your state's own tax code and whether it has adopted a conforming deduction. Set this expectation clearly with your employees: those who hear “no tax on tips” and assume every layer of tax on that income disappears are in for a surprise at filing time. Confirm current Maine guidance with your tax advisor or state revenue department.
Tip Credit Rules Vary by State
Some states let employers pay tipped employees a reduced cash wage and count tips toward the difference (a tip credit); others require the full state minimum wage in addition to any tips received. Check Maine's wage and hour rules for your specific tip-credit obligations. Either way, the OBBBA deduction applies the same way to the qualified tips an employee actually receives. It doesn't change how your base wage or tip-credit calculation works.
Only the FLSA-Required Overtime Premium Qualifies
Some states require overtime after a set number of hours worked in a single day, on top of the federal 40-hour workweek threshold. The OBBBA deduction only covers the premium required by the federal FLSA: the weekly 40-hour threshold. Any additional premium owed solely under a state's daily-overtime rule does not qualify for the federal deduction. If Maine has overtime rules that go beyond the FLSA, your payroll system needs to isolate the FLSA-required weekly premium separately so employees don't over-claim.
FICA Tip Credit (Section 45B): Available in All States
The federal FICA tip credit remains in effect, and for tax years beginning after 2024 the OBBBA extended it to certain beauty service businesses (barbering and hair care, nail care, esthetics, and body and spa treatments). If you operate a food and beverage business or one of those beauty service businesses, you may claim a tax credit equal to the employer's FICA share on tips above $5.15/hour. This is an employer credit (separate from the employee deduction), but it requires the same precise tip tracking that OBBBA reporting demands. Confirm with your payroll provider that your tip records support both the Section 45B credit calculation and the new W-2 reporting requirements.
6. Common Employer Mistakes
Treating Service Charges as Tips
Automatic gratuities added to bills are wages (not tips) regardless of how they're labeled. When distributed to employees, service charge revenue doesn't qualify for the OBBBA tip deduction. Keep service charges and tips in completely separate payroll buckets.
Not Isolating the OT Premium
Most payroll systems store total overtime pay, not just the half-time premium. Employees need the premium amount specifically to calculate their deduction. If your system doesn't isolate it, employees must reconstruct it manually from every paystub, or miss the deduction entirely.
Assuming Exempt Employees Qualify
Salaried exempt employees (managers, professionals, outside sales staff) don't qualify for the overtime deduction regardless of what you pay them. Communicating this incorrectly creates false expectations and difficult conversations.
Not Communicating That State Tax Rules Still Apply
Employees who hear "no tax on tips" may assume every tax on that income is gone. It isn't. This is a federal income tax deduction only. Clarify upfront what it does and doesn't cover. A surprised employee at filing time is an unpleasant conversation you can avoid.
7. Frequently Asked Questions
Does "no tax on tips" mean employers stop withholding FICA on tip income?
No. The OBBBA deduction only reduces the employee's federal income tax. Tips remain fully subject to FICA, FUTA, and any state payroll taxes that otherwise apply. Employers should not change tip withholding.
Which employees can claim the overtime deduction?
Only FLSA non-exempt employees whose overtime was legally required by the FLSA's weekly 40-hour threshold. Salaried exempt employees do not qualify, even if their employer pays them overtime voluntarily.
Are automatic gratuities (service charges) qualified tips?
No. Mandatory service charges added to a bill are wages, not tips, regardless of how they are distributed. Only voluntary tips the customer freely decides to give qualify for the deduction.
Do employers have to separately report tips and overtime on 2025 W-2s?
Not for 2025: the IRS provided transition relief so employers won't be penalized for reporting only aggregate wages on 2025 W-2s. Employers are encouraged to voluntarily provide the detail (for example, in Box 14) so employees can claim the deduction. Starting with 2026 Forms W-2, separate reporting is required: total cash tips in box 12 with code TP and the tipped occupation code in box 14b, and qualified overtime in box 12 with code TT.
What is the income limit for these deductions?
Both deductions phase out for taxpayers with modified adjusted gross income (MAGI) above $150,000 (single/head of household) or $300,000 (married filing jointly). Most tipped and hourly workers fall well below these thresholds.
Last reviewed: August 2026