Recent changes to the tax law for hospitality workers resulting from H.R. 1 (2025) may make it more confusing to manage deductions on tips and overtime. Effective January 1, 2025, and extending to December 31, 2028, the new rules come with limited guidance. Below, the retail and hospitality lawyers from MehaffyWeber discuss compliance challenges business owners may face under these new federal tax deductions and how to get help applying them to your company.
Language Addressing Retail Owners’ Obligations Under H.R. 1
Colloquially known as the One Big Beautiful Bill Act, H.R. 1 (2025) added multiple portions to the U.S. Tax Code in the retail and hospitality industries. Hourly employees can now apply for deductions on their income arising from tips and overtime wages.
Specific language of note from the Act includes the following:
- Section 70201 on tips:
- “There shall be allowed as a deduction an amount equal to the qualified tips received during the taxable year that are included on statements furnished to the individual…”
- “In general, the amount allowed as a deduction under this section for any taxable year shall not exceed $25,000.”
- “The amount allowable as a deduction … shall be reduced (but not below zero) by $100 for each $1,000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return).”
- “The term ‘qualified tips’ means cash tips received by an individual in an occupation that customarily and regularly received tips on or before December 31, 2024.”
- Section 70202 on overtime deductions:
- “The amount allowed as a deduction under this section for any taxable year shall not exceed $12,500 ($25,000 in the case of a joint return).”
- “The amount allowable as a deduction under subsection (a) (after application of paragraph (1)) shall be reduced (but not below zero) by $100 for each $1,000 by which the taxpayer’s modified adjusted gross income exceeds $150,000 ($300,000 in the case of a joint return).”
- “The term ‘qualified overtime compensation’ means overtime compensation paid to an individual … in excess of (their) regular rate.”
As a retail or hospitality business owner, you must take action to address these concerns and updates to the tax code. Doing so not only assists your employees but also enhances your company’s tax compliance efforts.
More Details on Tip Income and What Qualifies Under the Deduction
Hourly employees who regularly receive tips can deduct as much as $25,000 each year on their taxable income amounts. This total is per individual and includes tips they receive from credit card payments, cash, and pooled distribution methods. To qualify, tips must come from the customer voluntarily and at their discretion as to the amount.
When an employee reaches a certain threshold for their Modified Adjusted Gross Income (MAGI), this deduction begins to phase out. At $150,000 MAGI for single employees ($300,000 for married couples filing jointly), the deduction goes down $100 for every $1000 above the initial threshold.
The Overtime Pay Deduction
In Section 7202, the Act creates a new deduction addressing an employee’s overtime pay, allowing them to include up to $12,500 per person, or $25,000 per jointly filing married couple. The Fair Labor Standards Act (FLSA) mandates which workers receive overtime pay. State law supports this requirement under Texas Government Code Section 659-015, requiring overtime pay for anyone who works over 40 hours per week.
In Texas, employees receive 1.5 times their standard pay rate and can deduct that additional half-time income under H.R. 1. There is a similar phase-out threshold as the tip deduction, at $150,000 for individuals and $300,000 for couples filing jointly. As a business owner, the overtime pay deduction is simpler to track compared to tips, since you maintain records of the wages through your payroll system.
Mandatory Service Charges Can Introduce Confusion
For hotel and other hospitality owners, the law has triggered uncertainty on how to address mandatory service charges and distinguish them from tips. Correctly identifying and submitting these on tax forms requires examining Revenue Ruling 2012-18. This IRS notice discusses the 5 factors associated with a tip compared to a service charge:
- A tip must be paid voluntarily by the customer.
- There must be no consequence if the customer doesn’t pay a tip.
- A tip is not subject to negotiation.
- The customer alone determines whether to provide a tip and how much it will be.
- The customer chooses who receives the tip and when.
If you charge automatic gratuities for certain services or for parties over a certain number, these are considered mandatory service charges and are not tips. As the business owner, you should clearly indicate on pay statements where an employee receives income from mandatory charges versus tips, to minimize mistakes on their individual tax returns.
Compliance Recommendations for Business Owners
Current tax code (IRC Section 6721–6722) assesses penalties for filing inaccurate returns, yet this provision has an exception for the 2025 tax year. Employers and employees will not trigger penalties if they fail to provide a separate accounting for cash tips under IRS Notice 2025-62.
Our recommendation for retail and hospitality business owners is to closely review your current systems for payroll and point-of-sale. Verify that your programs accurately code for tips, service charges, and overtime categories. Review your year-end pay statement process to ensure workers get correct W-2 forms.
MehaffWeber Offers Advice on Managing Your Business Under H.R. 1
Overall, H.R. 1 offers potential complications for those owning and operating in the hospitality or retail sectors. To prepare for any issues going into 2026, we suggest meeting with a qualified retail and hospitality compliance attorney who can examine your current configurations for possible pitfalls.
At MehaffyWeber, our experienced team has served clients like you with honesty and integrity since 1946. We are your business and litigation allies across Texas. Contact us for help to update your systems for full compliance with tax and regulatory requirements.