The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, created two new above-the-line deductions: one for qualified tip income (up to $25,000) and one for qualified overtime pay (up to $12,500 for single filers, $25,000 for married filing jointly). If you qualify for either deduction and have not updated your W-4, you are likely overwithholding federal income tax on every paycheck.
Who Should Update Their W-4 Right Now?
Three groups of workers are most likely leaving money on the table by not updating their W-4:
- Tipped workers in IRS-designated occupations who receive cash or charged tips
- Hourly employees who regularly earn FLSA-required overtime at 1.5x their regular rate
- Itemizing taxpayers in high-tax states who benefit from the OBBBA's $40,000 SALT cap increase
If you fall into more than one category, you may need to combine adjustments on the Deductions Worksheet on the back of the W-4.
What OBBBA Actually Changed for Withholding
Under prior law, all wages including tips and overtime were fully taxable. OBBBA created deductions, not exclusions: the income still appears on your W-2, but an above-the-line deduction on Schedule 1 of Form 1040 offsets the taxable amount. Because these are deductions rather than pay reductions, employers still withhold on the full paycheck amount unless you instruct them otherwise via an updated W-4.
Qualified tips: Up to $25,000 of tips received in eligible tipped occupations. The IRS defines eligible occupations as those where tipping is customary and traditional (food service, hospitality, cosmetology). The deduction phases out by $100 for every $1,000 of AGI above $150,000 ($300,000 MFJ). Expires December 31, 2028.
Qualified overtime: Up to $12,500 of overtime pay ($25,000 for MFJ) for employees covered by the FLSA. State-law overtime, daily overtime, or voluntary extra hours outside an FLSA requirement generally do not qualify. Same phaseout: $100 reduction per $1,000 over $150,000 AGI ($300,000 MFJ). Expires December 31, 2028.
SALT deduction: OBBBA raised the Schedule A SALT cap from $10,000 to $40,000 for taxpayers with income below $500,000. Itemizers in California, New York, New Jersey, and other high-tax states may now have a larger deduction than their current W-4 reflects.
Tipped Workers
Enter your estimated annual qualified tip deduction on Line 1(a) of the Deductions Worksheet, which feeds into Step 4b of your W-4. If you received $20,000 in tips in 2025 and expect similar amounts in 2026, enter $20,000. Your employer will reduce withholding on each paycheck to reflect that deduction rather than letting it accumulate as a refund at filing. Confirm your occupation is on the IRS eligible occupation list before claiming the deduction.
Overtime Workers
Enter your estimated annual qualified overtime deduction on Line 1(b) of the Deductions Worksheet. Single filers can claim up to $12,500; married filing jointly up to $25,000. Only FLSA-mandated overtime at 1.5x the regular rate qualifies. If your overtime income varies throughout the year, use a conservative estimate to avoid underwithholding, or use the IRS Tax Withholding Estimator to model multiple scenarios.
SALT Itemizers
If your total state and local taxes now exceed $10,000 but fall under the new $40,000 SALT cap, you may be able to itemize for the first time or claim a larger itemized deduction than before. Update W-4 Step 4b to reflect your projected total itemized deductions minus the standard deduction for your filing status. For example, if you expect $35,000 in SALT plus mortgage interest and other deductions totaling $55,000, enter the difference between that total and the standard deduction on Line 4b.
How to Fill Out the 2026 W-4 Deductions Worksheet
- Download the current 2026 Form W-4 from IRS.gov.
- Go to the Deductions Worksheet on Page 3.
- Enter your estimated qualified tip deduction on Line 1(a), if applicable.
- Enter your estimated qualified overtime deduction on Line 1(b), if applicable.
- Add other expected deductions (mortgage interest, charitable contributions) on Line 1(c).
- Follow the worksheet instructions to subtract the applicable standard deduction and enter the result on Line 4b of Step 4.
- Give the updated W-4 to your employer. Changes take effect on the next payroll run.
Income Phaseout: Check Before You Claim
Both the tip and overtime deductions phase out if your AGI exceeds $150,000 ($300,000 MFJ). The deduction is reduced by $100 for every $1,000 of excess AGI. At $175,000 of AGI for a single filer, the tip deduction is reduced by $2,500 (from $25,000 to $22,500). Above roughly $400,000 of AGI, both deductions are fully phased out. High earners in tipped or overtime-heavy roles should run the math before updating their W-4 to avoid a surprise underpayment penalty at filing. See our guide to IRS underpayment penalty safe harbor rules for details on how to protect yourself if your withholding comes up short.
Use the IRS Tax Withholding Estimator
The IRS updated its Tax Withholding Estimator at IRS.gov/W4App to reflect OBBBA changes. It accepts your current pay stubs and prior-year return, then calculates how much you should have withheld for the rest of the year. This is the most reliable tool for workers with variable tips, irregular overtime, or complex withholding situations involving multiple income sources.
Have questions about whether you qualify for the OBBBA tip or overtime deduction, or need help calculating the right withholding for your situation? Contact TS CPA. We respond within the same day.