While we do not often report on proposed legislation, two provisions in the bill the House Ways and Means voted out of Committee on May 14th (and which was voted out of the House Budget Committee on May 18th) are worthy of attention, as they reflect how two of President Trump’s campaign promises are beginning to take shape. Sections 110101 and 110102 of the Ways and Means Committee’s “One, Big, Beautiful Bill” would give certain workers an above-the-line deduction for “qualified tips” and “qualified overtime compensation” for taxable years beginning after December 31, 2024, and ending for taxable years beginning after December 31, 2028. Assuming the effectives dates relate to the service provider’s returns, and most service providers have a calendar year return and are on the cash method of accounting, the deduction would apply to tips and overtime paid in 2025 through 2028. This means the deductions are proposed to be retroactive and proposed to apply to amounts paid even before enactment of the bill.
As an above-the-line deduction, service providers will be able to directly reduce their gross income, whether they itemize or take the standard deduction, by the amount of the qualified tips or overtime. Making this deduction available to the worker creates reporting and withholding obligations for the service recipient, as discussed in more detail below.
In order to be deductible as qualified overtime compensation, the payment must be overtime paid as required under section 7 of the Fair Labor Standards Act that is in excess of the regular rate (as used in that section) at which such individual is employed. Qualified overtime compensation does not include any amount treated as a qualified tip.
In order to be deductible, qualified tips generally must be paid voluntarily to a person who works in an occupation which traditionally and customarily received tips on or before December 31, 2024. The Secretary of the Treasury is directed to provide a list of occupations that traditionally and customarily received tips in 2024 and before. As proposed, the deduction for qualified tips applies for both employees receiving a Form W-2, and independent contractors receiving a Form 1099-K or Form 1099-NEC, and includes amounts reported by the business on Form 4137. Those whose personal business provides services in accounting, health, law, actuarial science, athletics, brokerage services, consulting, financial services, or the performing arts would not be allowed to claim the tip deduction. In the case of tips received in the course of a trade or business, the deduction is proposed to be limited to gross receipts from the business less costs of goods sold and expenses allocable to such receipts. The Secretary of the Treasury is directed to prescribe regulations to prevent abuse of the deduction and reclassification of income as tips.
FICA and SECA still apply
Notably, the proposal does not mention FICA (social security and Medicare) taxes or self-employment tax, so both qualified tips and overtime would remain subject to those taxes, and employers would continue to be required to withhold FICA taxes on the qualified tips and overtime (to the extent otherwise required).
Limitations on the deductions
Further, as written, the deductions are limited so that only workers not considered highly-compensated and those who have work-eligible social security numbers are eligible; married individuals must also include their spouse’s social security number in order to be able to claim the deduction. For 2025, a highly compensated individual is one who makes $160,000 or more. It is not clear from the proposed legislation whether businesses will need to identify workers who are highly-compensated, or whether the individuals will self-identify on their individual returns by not claiming the deduction.
Reporting requirements
The qualified overtime and qualified tip amounts are required to be reported on the Form W-2, or the Form 1099 (e.g., Form 1099-NEC or 1099-K) in the case of tips paid to non-employees. Additionally, Forms 1099 will need to include information regarding whether the tip is received in an occupation that traditionally and customarily receives tips.
Open questions
- Withholding and Reporting. It is unclear whether, for employees, the qualified tips and overtime would remain subject to federal income tax withholding, though the Secretary of the Treasury is directed to modify the income tax withholding tables to account for these deductions. Additional clarity in the form of guidance from the IRS and Treasury will be required in order for employers to understand whether they are to include the qualified tips and qualified overtime as federal wages in Box 1 of Form W-2, whether federal income tax withholding is required, and whether Forms W-4 will need to be modified to take these deductions into account. Guidance will also be necessary to understand where on each of the Forms W-2 or 1099 (and with what, if any, coding) the special reporting of qualified overtime or tips will be required.
- Interplay with Proposed Changes to 1099-K and 1099-NEC Reporting Thresholds. Given the language in the proposed bill that provides for the above-the-line deduction for tips only for amounts “that are included on statements furnished to the individual,” guidance will be needed to clarify the interplay between the qualified tips deduction and the proposed changes to section 6050W and 6041 reporting. Specifically, the proposed bill would reinstate the pre-2021 de minimis exception to Form 1099-K reporting, so that Form 1099-K would be required only if applicable payment card or platform payments for a year exceed $20,000 and there are more than 200 transactions; the proposed bill would also increase the threshold for Form 1099 reporting, where Forms 1099, such as Form 1099-NEC, would be required only for amounts paid in excess of $2,000, subject to inflation. If these proposed reporting threshold changes are adopted, Forms 1099 may be required to be issued to significantly fewer tip recipients. Accordingly, guidance will be needed to understand whether reporting of qualified tips will be required in order to allow individuals to claim the deduction, even in cases where reporting would not otherwise be required as a result of the proposed changes to the thresholds in sections 6041 and 6050W.
- State Tax Impact. It is unclear whether states, particularly those that conform to the Internal Revenue Code, will similarly exempt qualified overtime or qualified tips from state income taxes and/or state income tax withholding. Guidance at the state level as to how such amounts should be reported on Forms W-2 and 1099 for state purposes will also be needed.
Key Takeaways
- For Workers. The above-the-line deductions included in Sections 110101 and 110102 of the Ways and Means Committee’s “One, Big, Beautiful Bill” will provide some relief from income taxation to workers who earn qualified tips and qualified overtime, make under $160,000, and have work-eligible social security numbers. However, social security and Medicare taxes will still apply to these tips and overtime, so they will not be entirely tax-free.
- For Employers and Businesses. Should these provisions become law, businesses will need to comply with the special reporting provisions, which apply equally to employees and independent contractors, by tracking the qualified tips and overtime in order to be able to separately report them on Forms W-2 and 1099, as required. Businesses will also need to follow any similarly enacted state provisions to ensure they are compliant at both the federal and state levels. Income tax withholding rules may also change as a result of these provisions. Given the high-profile nature of the campaign promises to end taxation of tips and overtime, the retroactive nature of the proposed changes, and the reporting and potential withholding consequences, businesses that pay tips and overtime should begin considering what they can do now to be prepared to comply with the proposed new obligations.
The legislation continues to work its way through House Committees and is expected to be voted on by the full House within weeks. The attention will then shift to the Senate. Republican leadership aims to pass the reconciliation bill and send it to the President for signature by July 4th, although that timing could lag.