No Tax on Tips and Overtime: What Los Angeles Workers and Employers Need to Know
By the team at Bornazyan & Bornazyan LLP
If you work for tips or clock overtime anywhere in Los Angeles, you have probably heard the good news: those wages are now “tax-free.” It is also one of the most misunderstood parts of the new federal tax law. The honest version is this. Yes, there is real relief. But it is a deduction with limits, it does not erase every tax, and here in California it comes with a catch that can leave you owing the state at tax time. Here is what actually changed, and what it means if you live and work in LA.
The quick version
The One Big Beautiful Bill Act, signed into law in July 2025, created two new deductions for the 2025 through 2028 tax years: one for qualified tips and one for qualified overtime. They are deductions, not exemptions. You can take them whether you claim the standard deduction or itemize. But your tips and overtime are still subject to Social Security and Medicare taxes, and in California they are still subject to state income tax. That last point matters a great deal in Los Angeles, so we will come back to it.
What the tips deduction covers
- Up to $25,000 per return.
- Only “qualified” tips, earned in occupations on the IRS official list of jobs that customarily received tips on or before December 31, 2024. That list is now finalized and covers more than 70 occupations, from bartenders to hairstylists. Think servers, bartenders, salon workers, personal trainers, and many gig economy workers. (Self-employed workers can claim it too, but not more than their net income from that business.)
- The deduction phases out once your modified adjusted gross income passes $150,000 (single) or $300,000 (joint).
- You need a valid Social Security number, and married couples must file jointly to claim it.
What the overtime deduction covers
- Up to $12,500 (single) or $25,000 (joint).
- Only the premium “half” of federal time-and-a-half overtime, meaning the extra amount above your regular rate.
- The same income phase-outs apply.
- Only overtime required by the federal Fair Labor Standards Act (hours over 40 in a week) qualifies. This is where Los Angeles workers need to pay close attention.
Tips vs. overtime at a glance
| Tips vs. overtime at a glance | No Tax on Tips | No Tax on Overtime |
|---|---|---|
| Maximum deduction | $25,000 per return | $12,500 single / $25,000 joint |
| What qualifies | Tips in IRS-listed occupations | The FLSA time-and-a-half premium only |
| Income phase-out (MAGI) | Over $150k single / $300k joint | Over $150k single / $300k joint |
| Years in effect | 2025 to 2028 | 2025 to 2028 |
| Still owe Social Security/Medicare? | Yes | Yes |
| Still owe California income tax? | Yes | Yes |
The California catch every Tax Payer should know
Here is the part the national headlines skip. These are federal deductions, and California has not adopted them. Your tips and overtime still count as taxable income on your California return, taxed at the state’s regular rates, which run from 1% all the way up to 13.3%. A bill in Sacramento has been proposed to bring California into line starting in 2026, but it is not law yet. Until it passes, you owe California tax on every tipped and overtime dollar.
There is a second wrinkle that is unique to our state. The federal overtime deduction only applies to FLSA overtime, which starts after 40 hours in a week. California also has daily overtime, the time-and-a-half you earn for working more than 8 hours in a single day. That daily overtime is required by California law, not federal law, so it does not qualify for the federal deduction at all. Plenty of LA workers hit daily overtime without ever crossing 40 hours in a week, and for them the benefit is much smaller than the headlines suggest.
Add it all up and the risk is real. An LA worker could see less federal tax withheld, assume the whole thing is covered, and then get a bill from California in April. If you earn tips or overtime, the safest move is to set money aside for your state tax now.
What Los Angeles workers should do
- Check your pay stubs and make sure tips and overtime are tracked separately, so you can actually prove and claim the deduction.
- Set money aside for California tax, because the state is not giving you this break yet.
- Review your Form W-4 so your withholding reflects your real situation.
- Keep clean records of your tips, including cash tips and shared tips.
What LA employers need to prepare for
If you run a restaurant, bar, salon, or any business with tipped or hourly staff, your reporting duties are changing. For 2025, the IRS granted transition relief, so no new boxes are required on this year’s forms. But beginning with 2026 wages, the W-2s you issue in early 2027, you will need to report qualified tips and each employee’s Treasury Tipped Occupation Code in the new W-2 boxes, and separately account for FLSA overtime. Now is the time to update your payroll and point-of-sale systems and talk with your accountant, so you are not scrambling later. One warning: reclassifying regular wages as tips to inflate the deduction is specifically prohibited, so accurate books matter more than ever.
We can help you get this right
The income limits and occupation rules are fiddly, and California adds its own twist on top. If you are an LA worker who wants to claim these deductions correctly, or an employer who needs to get payroll ready for 2026, we do this every day. Learn about our tax preparation and tax planning services, or request a free consultation and we will walk through your specific numbers.
Frequently asked questions:
Not entirely. The new law lets you deduct qualified tips (up to $25,000) and qualified overtime (up to $12,500 single, $25,000 joint) from your federal taxable income for 2025 through 2028. They are still subject to Social Security and Medicare taxes, and in California they are still subject to state income tax.
Yes, for now. California has not conformed to the federal deductions, so tips and overtime remain fully taxable on your state return at rates from 1% to 13.3%. A proposed state bill could change this for 2026 onward, but it is not law yet.
No. The federal deduction only covers FLSA overtime, meaning hours over 40 in a week. California’s daily overtime, for working more than 8 hours in a day, is required by state law and does not qualify.
No. You can claim both whether you itemize or take the standard deduction, as long as you meet the income and occupation rules and have a valid Social Security number.
No. The IRS final regulations exclude automatic gratuities and mandatory service charges, such as an automatic 18% charge added for a large party. Only voluntary tips left by the customer qualify. This is an important distinction for LA restaurants and the staff who work in them.
For 2025, transition relief applies. Beginning with 2026 wages, you must report qualified tips and occupation codes on the W-2 and account for FLSA overtime separately. Update your payroll systems now and check with your CPA.
It depends on your tax bracket, because this is a deduction, not a credit. It lowers your taxable income by up to the amount you deduct, so your savings equal that amount multiplied by your federal tax rate. For example, a worker in the 12% bracket who deducts $10,000 in tips saves roughly $1,200 in federal tax. Keep in mind that California does not offer the same break, so your state tax does not go down.
Both deductions apply to the 2025 through 2028 tax years. Unless Congress extends them, they expire after 2028.
You claim it on your federal Form 1040 when you file. For 2025, the IRS granted transition relief, so the amounts may need to be calculated from your records rather than pulled from a W-2 box. Starting with 2026 wages, your employer will report qualified tips and your occupation code on your W-2. A tax preparer can make sure you claim the correct amount.
es. The deduction only reduces your federal income tax. Your tips and overtime are still subject to Social Security and Medicare (FICA) taxes, and in California they are still subject to state income tax.
This article is general information, not personalized tax advice. Tax rules change and every situation is different, so please contact us before you act on anything here.
