1.3 New Above-the-Line Deductions

Deduction for Qualified Tip Income — OBBBA §70201 / FS-2025-03

Beginning with TY2026, taxpayers who receive tips in a qualifying occupation may deduct up to $25,000 of qualified tip income. This deduction is claimed above-the-line on the new Form 1040 Schedule 1, Part II-A (Additional Deductions). Tips that are deducted are still reported as gross income, so Social Security and Medicare taxes on those tips still apply — the deduction only reduces income tax, not FICA. This is a critical distinction practitioners must communicate clearly to tipped-wage clients.

The IRS Q&A on qualified tip income addresses which occupations qualify, how employer-allocated tips are handled, and how the deduction interacts with the FICA tip credit. The deduction is not available for tips received from Specified Service Trades or Businesses (SSTBs). Employers must separately track qualifying tips and report them on W-2 Box 12 Code TP (covered in Lesson 8). Code TS is used for tips from SSTB employers that do not qualify for the deduction.

Rule	Detail
Maximum deduction	$25,000 per taxpayer per year
Qualifying occupations	Occupations where tipping is customary — food service, beverage service, hair and beauty, delivery. Treasury publishes the qualifying occupation list.
W-2 tips (Box 7)	Employer-allocated tips in Box 8 may not qualify — only tips actually received and reported by the employee
FICA tip credit (§45B)	Employers may still claim the FICA tip credit; the employee tip deduction does not eliminate this credit
Income phaseout	Phases out above $160,000 (single) / $320,000 (MFJ) — $50 reduction per $1,000 over threshold
Self-employed	Tips received by self-employed workers in qualifying occupations also qualify; reported on Schedule C
W-2 Code	Employer reports qualifying tip amount in Box 12 Code TP; Code TS for non-qualifying (SSTB) tips

Deduction for Overtime Pay — OBBBA §70202 / IRS Q&A

A new deduction of up to $12,500 ($25,000 for MFJ) is allowed for qualified overtime compensation. Qualified overtime is the premium pay required under the Fair Labor Standards Act (FLSA) — the amount paid above the regular rate for hours worked over 40 per week. Only the overtime premium qualifies, not the regular-rate pay for those hours. The IRS Q&A on qualified overtime compensation provides detailed guidance on how to calculate the deductible amount from W-2 Box 12 Code TT or directly from pay stubs.

The deduction is not available to employees who are exempt from FLSA overtime requirements (generally salaried employees in executive, administrative, or professional roles). Many clients who work long hours as salaried employees will not qualify, while hourly workers in manufacturing, healthcare, retail, and transportation are the primary beneficiaries. Employers must separately identify and report the FLSA overtime premium on W-2 Box 12 Code TT.

Rule	Detail
Max deduction — Single / MFS / HOH	$12,500
Max deduction — MFJ	$25,000
What qualifies	FLSA overtime premium only — the excess of 1.5× regular rate over the regular rate for hours over 40/week
Income phaseout	Phases out above $150,000 (single) / $300,000 (MFJ) — reduced proportionally; no floor
Employer reporting	Overtime premium must be separately identified on W-2 Box 12 Code TT
FLSA-exempt employees	Salaried exempt workers do not qualify — deduction limited to FLSA-required overtime premium
Self-employed workers	Not eligible — deduction is limited to FLSA-covered employment compensation

Auto Loan Interest Deduction — OBBBA §70203

For the first time since 1986, interest on personal vehicle loans is deductible for TY2026 and beyond. The deduction is above-the-line and available to both itemizers and non-itemizers. The vehicle must be a passenger automobile with a final assembly point in the United States — a key eligibility requirement. Foreign-assembled vehicles, even popular brands, do not qualify. Practitioners should advise clients to verify assembly location before purchasing or planning around this deduction.

Self-employed taxpayers using the standard mileage rate cannot separately deduct auto loan interest as a vehicle expense — it is considered included in the per-mile rate. However, the personal-use portion of auto loan interest may be deductible under OBBBA §70203 as an above-the-line personal deduction, even for business-use vehicles where the business interest is already deducted under §163. These are separate and distinct deduction mechanisms covering different portions of the same loan.

Rule	Detail
Eligible vehicle	Passenger automobiles with final assembly in the United States
Deductible amount	Interest paid on qualified vehicle loan during the tax year
Business use vehicles	Only personal-use portion of interest is deductible under §70203; business portion remains under §163
Income phaseout	Phases out above $100,000 (single) / $200,000 (MFJ)
Lender reporting	IRS expected to require auto lenders to report qualifying interest — similar to Form 1098 for mortgage interest
New vehicles only?	No — the deduction applies to existing auto loans on qualifying vehicles for interest paid in TY2026 forward

Enhanced Senior Deduction — OBBBA §70103

The OBBBA created a new $6,000 additional deduction for taxpayers age 65 or older as of December 31, 2026. This is separate from and in addition to the existing additional standard deduction for age. The new senior deduction is available regardless of whether the taxpayer itemizes. A single taxpayer who is 65 may claim: $16,100 (standard deduction) + $2,050 (additional for age) + $6,000 (enhanced senior) = $24,150 in combined deductions before any itemized deductions.

The phaseout reduces the $6,000 deduction at the rate of 6% per dollar of AGI above the threshold — a $6 reduction for every $100 over the threshold. The deduction is fully phased out at $175,000 AGI for single filers ($75,000 threshold + $100,000 range) and $250,000 for MFJ. This is a soft phaseout — clients just above the threshold still receive a partial benefit.

Rule	Detail
Deduction amount	$6,000 per qualifying taxpayer
Age requirement	Age 65 or older by December 31, 2026
MFJ — both spouses qualify	$12,000 combined
Income phaseout	Reduced 6% per dollar of AGI above $75,000 (single) / $150,000 (MFJ). Fully phased out at $175,000 (single) / $250,000 (MFJ)
Available to itemizers?	Yes — available whether the taxpayer itemizes or takes the standard deduction
Stacks with additional std deduction?	Yes — both can be claimed independently