Introduction
In a bold move aimed at boosting take-home pay for working-class Americans, Donald Trump’s 2025 tax proposal includes a striking provision: eliminating federal income tax on tips and overtime pay. If enacted, this could lead to significant savings for millions of hourly workers, restaurant staff, hospitality professionals, and gig economy earners.
This blog breaks down how the provision would work, the Internal Revenue Code changes it may impact, who benefits, and how to prepare for compliance and documentation.
What the Proposal Says
- Overtime income and tips would be exempt from federal income tax, but would still likely be subject to:
- Social Security & Medicare (FICA)
- State taxes, depending on local law
- The tax-free status would only apply up to a certain income limit, potentially phased out at higher earnings (exact thresholds pending legislation).
IRC Sections Potentially Affected
- IRC §3401 – Definitions of wages for income tax withholding
- IRC §3121 – Defines wages subject to FICA
- IRC §61(a) – General gross income inclusion rules
If passed, Congress would amend §3401 and §61 to exclude overtime and tip income from gross income for federal income tax purposes.
IRS Forms Affected
- Form W-2 – Employers must separate tax-exempt tip/overtime income
- Form 1040 – Adjusted to exclude qualified overtime/tip income from taxable wages
- Form 941 – For employer payroll tax reporting (still required for FICA)
Example Scenario
Case: Maya, Restaurant Server in New Jersey
- Regular wages: $28,000
- Tips earned: $14,000
- Overtime (10 hrs/week @ 1.5x): $6,500
Current tax liability (2024):
- Full $48,500 taxed federally
- Estimated federal income tax: $3,500
Under Trump’s 2025 Proposal:
- $20,500 (tips + OT) excluded
- Taxable wages = $28,000
- Estimated federal tax: $1,700
Annual tax savings: $1,800+
Step-by-Step IRS Compliance Guide
- Track Overtime Separately – Ensure your payroll provider distinguishes regular vs. overtime hours.
- Accurately Report Tips – Use daily tip logs or POS systems to track tips consistently.
- Check W-2 for Breakdown – Review Box 1 and Box 8 to confirm tip income exclusion.
- Use Updated Form 1040 – Ensure you file using the new version if the exemption becomes law.
- Coordinate with State Tax Laws – Many states may still tax tip and OT income unless they conform to federal changes.
- Speak with a CPA – Understand how this impacts withholding, refunds, and your total tax liability.
Conclusion
If passed, the exemption of overtime and tip income from federal tax would be a landmark change giving real financial relief to service industry and hourly wage workers. However, proper reporting, payroll coordination, and tax planning are essential to take full advantage of this benefit while remaining compliant.
Call to Action
Do you earn income through tips or regular overtime? You could see thousands in tax savings under Trump’s 2025 tax proposal but only if your earnings are properly documented and filed under the new rules.
Get professional advice tailored to your income type:
Book a meeting with Anshul Goyal, CPA, EA, FCA
About Our CPA
Anshul Goyal, CPA, EA, FCA, is a U.S.-licensed Certified Public Accountant and IRS-authorized Enrolled Agent. With experience in payroll taxation, wage planning, and cross-border tax issues, he supports hourly earners, tipped workers, and small business employees in understanding their rights and obligations under U.S. tax law.
Disclaimer
This blog is for informational purposes only and should not be considered tax, legal, or financial advice. IRS rules may change depending on final legislative decisions. Always consult a licensed tax professional for personalized guidance.