On July 4, 2025, President Donald Trump signed into law a sweeping tax bill that promises to reshape the financial landscape for millions of American workers, particularly those in the service and labor sectors. Dubbed by the White House as a “tax independence day” for working-class Americans, this legislation eliminates federal income taxes on a significant portion of tip income and overtime pay, effective from 2025 through 2028.
This landmark move fulfills a key campaign promise Trump made during a 2024 rally in Las Vegas, aiming to bolster support among voters in pivotal swing states. The new law allows employees to deduct up to $25,000 in tip income from their federal income taxes, a substantial change from current IRS rules that require workers to report all tips over $20 per month as taxable income. Moreover, federal income tax on overtime pay is also eliminated up to $25,000 for married couples filing jointly and $12,500 for single filers.
“An estimated four million individuals receive tip income. So those people could see a significant tax benefit,” said Mark Luscombe, principal tax analyst with Wolters Kluwer Tax & Accounting. Importantly, these deductions are “available to non-itemizers,” meaning workers can claim them even if they take the standard deduction, a boon for many service industry employees who typically do not itemize.
Under the new system, workers will still need to report their tip income and pay payroll taxes such as Social Security and Medicare. Although federal income tax will be withheld from paychecks, those amounts will be refunded when employees file their tax returns, effectively removing the tax burden on a portion of tips and overtime earnings. However, the tax benefits phase out for higher earners: individual filers with modified adjusted gross income (MAGI) above $150,000 and married couples filing jointly above $300,000 will see their deductions reduced by $100 for every $1,000 over these thresholds.
This tax break is not limited to employees alone. Some independent contractors and small business owners may qualify for these deductions, provided their business income exceeds deductions, losses, and costs, including the cost of goods sold. The IRS is expected to issue further guidance to prevent businesses from restructuring solely to exploit these tax advantages.
While the headline figures sound promising, the benefits are unevenly distributed. A study by the nonpartisan Tax Policy Center reveals that households earning $33,000 or less will see minimal impact, as many already owe little to no federal income tax. In fact, 40% of households reporting tip income will not receive any tax benefit under the new law. Conversely, 60% of households with tip income—roughly 2% of all U.S. households—will benefit, with average tax savings of about $1,800 annually.
Among those earning less than $33,000, only 1.4% will benefit, with an average after-tax income increase of $450 per year. This highlights a crucial limitation: the tax break tends to favor middle- and upper-income earners who receive tips or overtime pay, while many lower-income workers, who arguably need relief most, may see little change.
The legislation also tackles overtime pay, which must be compensated at time and a half for hours worked beyond 40 per week. Under the new law, employees can deduct federal income taxes on overtime wages—up to $12,500 for singles and $25,000 for married couples filing jointly—when filing tax returns, regardless of whether they itemize deductions. The White House estimates the average overtime worker will save between $1,400 and $1,750 annually.
However, experts caution that this tax relief may have unintended consequences. The Tax Foundation, a nonprofit tax policy group, warns that removing income taxes on overtime could “distort” the labor market by encouraging more workers to take overtime shifts. This shift could make hourly roles more appealing relative to salaried positions that are exempt from overtime rules. Luscombe adds, “Although the bill tries to restrict businesses not currently relying on tip income and overtime pay from seeking to take advantage of these proposed changes, it is still possible that there could be shifts toward tip income and more overtime pay to try to take advantage of the deductions.”
From a fiscal perspective, the Joint Committee on Taxation estimates the tip income deduction will reduce federal revenues by $40 billion between 2025 and 2034. Meanwhile, the Congressional Budget Office projects that exempting overtime pay from federal income tax will cost $124 billion through 2028. These significant revenue losses raise concerns about the growing federal deficit and the long-term sustainability of such tax breaks.
Despite these fiscal challenges, the new tax law represents a bold attempt to increase take-home pay for workers who rely heavily on tips and overtime. For many in hospitality, food service, and retail, this could translate into hundreds or even thousands of dollars saved annually, providing a welcome boost to household finances.
Yet, as the law rolls out, it will be essential for workers to understand the nuances of reporting income correctly and taking full advantage of the deductions. Taxpayers should be vigilant in tracking their earnings and consulting tax professionals to navigate the changes effectively.
Ultimately, while this tax reform offers clear benefits to certain segments of the workforce, it also underscores the complexities of tax policy and the challenges in designing measures that equitably support all income groups. As the effects of this legislation unfold over the coming years, its true impact on workers, businesses, and the federal budget will become clearer.
