This article is for S Corp tier members who run payroll through Collective. If you're on the LLC tier, the tip and overtime deductions may still apply to you. Income is reported differently when there's no payroll, though, so reach out to your Collective team for guidance specific to your business.
Two newer federal tax deductions, often called "no tax on tips" and "no tax on overtime," let many workers keep more of what they earn. As an S Corp owner, you're both the owner of your business and its employee, and you may have employees of your own. Whether anyone can claim these deductions depends largely on how tips and overtime are recorded in payroll during the year. Getting that right puts you and your team in the best position at tax time.
| Deduction | You, as owner-employee | Your employees |
|---|---|---|
| No tax on tips | May apply if your work and tips qualify | May apply if their work and tips qualify |
| No tax on overtime | Generally doesn't apply | May apply if they're eligible for overtime under federal law |
What the deductions are
Under current law, both deductions are available for tax years 2025 through 2028. Each is claimed on the Individual Tax Return (ITR) using a schedule called Schedule 1-A, and either can be taken whether or not the filer itemizes.
| No tax on tips | No tax on overtime | |
|---|---|---|
| Yearly cap | Up to $25,000 of qualified tips | Up to $12,500 of qualified overtime, or $25,000 on a joint return |
| Income limit | Both begin to phase out once modified adjusted gross income (total income with certain adjustments) passes $150,000, or $300,000 if filing jointly | |
| What it reduces | Federal income tax only. Social Security and Medicare taxes still apply, and payroll withholding doesn't change. | |
If you're married, you'll need to file a joint return to claim either deduction.
What counts as a qualified tip
Not every tip qualifies. In most cases, a tip is qualified when all of the following are true:
- The work is on Treasury's list of tipped occupations. The list includes more than 70 occupations in categories like food and beverage service, hospitality, personal services, personal appearance and wellness, and transportation and delivery. What matters is the work actually done, not the job title.
- The tip was voluntary. It has to come from a customer or through a tip-sharing arrangement, like a tip pool. Mandatory service charges and automatic gratuities generally don't count unless the customer could remove or change them.
- It was paid in cash or a cash equivalent. Credit and debit cards, checks, gift cards, and payment apps all count.
What counts as qualified overtime
The overtime deduction is narrower than it sounds. In most cases, overtime is qualified when all of the following are true:
- The worker is eligible for overtime under the Fair Labor Standards Act (FLSA), the federal law that sets overtime rules. Eligibility depends on the work someone does and how they're paid, not their job title. Many salaried managers and professionals are exempt, meaning federal law doesn't require overtime pay for them.
- The overtime is required by federal law. In general, that means hours over 40 in a single workweek, paid at one and a half times the regular rate. Overtime paid only because of state law (like daily overtime in some states), a union contract, or company policy doesn't count.
- Only the extra pay counts. The deduction covers the premium portion, the "half" in time-and-a-half, not the full overtime pay. For example, an employee earning $20 an hour who works 45 hours in a week earns $150 for those 5 overtime hours, and $50 of that is qualified overtime.
- It's reported on the W-2. Starting with tax year 2026, qualified overtime can only be deducted if it's reported separately on the employee's W-2.
Why the overtime deduction generally doesn't apply to owners
Under current IRS guidance, an employee who owns at least 20% of the business and is actively involved in managing it is generally treated as an exempt executive under the FLSA. Federal overtime rules don't apply to them, so there's no qualified overtime to deduct. For most S Corp members, that describes your role in your own business.
This comes down to your ownership and role, not how your pay is set up, so overtime you pay yourself generally won't qualify. Where the overtime deduction can make a difference is for employees you hire who are eligible for overtime. Recording their overtime correctly is what makes it possible for them to claim it.
Why tips and overtime need to run through payroll
The IRS only allows these deductions for amounts that show up on an official tax form, like a W-2. Tips have one fallback: they can also be reported directly on the ITR. Overtime doesn't. For tax years after 2025, qualified overtime that isn't on the W-2 can't be deducted.
Because you're an owner-employee of your S Corp, your tips belong on your W-2. If you have employees, their tips and overtime belong on theirs. Recording both in payroll as they happen keeps W-2s accurate at year end and helps keep your S Corp in good standing. To record tips and overtime, see How to add tips and overtime to payroll.
When tips and overtime run through payroll, you and your employees don't need to take extra steps to report them. On the W-2, qualified overtime appears in Box 12 with code TT, which is the amount your employees will use when they file.
Lowering withholding during the year
Payroll still withholds federal income tax on tips and overtime, since the deductions are claimed at tax time. If you or an employee expect to claim either deduction, you can account for it on a new Form W-4, the form that tells payroll how much to withhold. The current W-4 includes a deductions worksheet for estimated qualified tips and overtime. This is optional, and it can mean a larger paycheck now instead of a larger refund later. If you'd like to update your own withholding, reach out to your Collective team.
Recording tips and overtime in payroll
If you have employees who are eligible for overtime, record their overtime hours on each payroll, separate from their regular hours. Overtime is based on hours worked in each workweek, so keep a record of each employee's hours week by week, even if you run payroll every two weeks or twice a month. For step-by-step instructions for both tips and overtime, see How to add tips and overtime to payroll.
If tips or overtime weren't reported through payroll
It's common to realize after the year ends that tips or overtime weren't recorded separately. The options are different for each.
For tips, there are two ways forward, and the right one depends on your numbers:
- A corrected W-2 (Form W-2c). If the wages already paid are equal to or more than the tip amount, part of those wages can be reclassified as tips on a corrected W-2. A corrected W-2 can only relabel wages already paid. It can't add new income on top of them.
- Reporting tips on the ITR. If tips were more than the wages paid, or you'd rather not wait for a corrected W-2, the tips can be reported directly on the ITR.
For overtime, a corrected W-2 is the only option. Starting with tax year 2026, an employee can't add missing overtime on their own return or use a substitute W-2. If you think an employee's overtime wasn't recorded correctly, reach out to your Collective team as early as you can, ideally before W-2s go out.
Common misconceptions
"All my tips and overtime are tax free." Both deductions lower income tax only. Social Security and Medicare taxes still apply, and each deduction is capped.
"If I get tips, I qualify." The work has to be on Treasury's list, and the tips have to be voluntary.
"I work long hours, so I can deduct overtime too." As an owner who holds at least 20% of the business and helps run it, you're generally exempt from federal overtime rules, so there's no qualified overtime to deduct.
"All of my employee's overtime pay is deductible." Only the premium portion of overtime required by federal law qualifies, not the full overtime pay.
"Missing amounts can be added at tax time." Tips can be reported on the ITR if they're missing from the W-2. Overtime can't. It has to be on the W-2 or a corrected W-2.
Next steps
To get started, head to Payroll in your Collective dashboard and record tips and overtime on your next payroll. For steps, see How to add tips and overtime to payroll. If you aren't sure whether your work, your employees' roles, or your tips qualify, reach out to your Collective team before you file. They're here to help you sort out the reporting so you're ready at tax time.
For more detail, see these IRS and Department of Labor resources:
- Final regulations listing tipped occupations (IR-2026-49)
- How to take advantage of no tax on tips and overtime (Tax Tip 2026-06)
- Questions and answers about the deduction for qualified overtime compensation (FS-2026-13)
- Occupations that customarily and regularly received tips
- Schedule 1-A, Additional Deductions
- Tip recordkeeping and reporting
- Overtime pay requirements of the FLSA (DOL Fact Sheet #23)
The information contained in this article is provided for informational purposes only and should not be construed as legal, financial, or tax advice. It is not intended to be a substitute for obtaining legal, accounting, or other financial advice from an appropriate and/or licensed adviser, or for the purpose of avoiding U.S. Federal, state or local tax payments and penalties.