Dear Client,
A very Merry Christmas from all of us at MD CPA!
As we draw ever nearer to the coming tax season, what better way to capture the holiday spirit than sharing information regarding several “gifts” in the recent tax bill!
The “One Big Beautiful Bill Act” (OBBBA) was the subject of many news stories and articles for multiple months prior to its passing.
Given my profession, I followed these stories with special interest, curious as to what was being discussed on both sides of the political aisle.
While I am keenly aware that a nuanced understanding of tax law is not to be expected from journalists (or politicians for that matter), so many of these stories were misleading, confused, or simply wrong.
The result has been mass confusion and misinformation regarding OBBBA and its contents.
I gave a general (and hopefully readable) overview of the more important tax provisions in my “One Big Beautiful Memo” earlier in the year. However, there are several specific items that require a more detailed explanation: the four “no tax” headline items.
These are:
- No tax on Social Security income
- No tax on tips
- No tax on overtime
- No tax on auto loan interest
The problem with headline items is that they are just that: headlines designed to catch your attention. There are elements of truth in all four, but they are oversimplifications at best, and therefore misleading.
In this letter, I will try to clarify the reality of these items, giving you all the fine print that was left out when these were discussed on the news.
No Tax on Social Security – Personal Exemption for Seniors
This topic was fully explained in my first memo, but here it is again in full.
One of President Trump’s campaign promises was to end tax on Social Security benefits.
This is not that.
There are various rules prohibiting the enactment of Social Security changes through budget reconciliation, and as OBBBA was passed through the reconciliation process, legislators were unable to include any direct Social Security provision.
However, the OBBBA did grant up to a $6,000 personal exemption deduction to taxpayers who are age 65 or older by the end of the taxable year, subject to modified adjusted gross income (MAGI) limitations.
Eligible individual taxpayers may claim the full $6,000 deduction until their MAGI reaches $75,000. The deduction then phases out by 6% of the amount (if any) by which a taxpayer’s MAGI exceeds $75,000, phasing out completely when the excess reaches $100,000 (6% of $100,000 = $6,000). Consequently, an individual taxpayer with MAGI of $175,000 or more is not eligible for the deduction.
Married filing joint taxpayers meeting the age requirement are eligible for a higher maximum deduction ($12,000) and are granted a higher MAGI range ($150,000 – $350,000).
If only one spouse meets the age requirement, the potential deduction amount remains that of an individual taxpayer ($6,000), but a higher MAGI range ($150,000 – $250,000) is granted.
Example
Mike realizes that his Tai Chi lessons are more than his post-retirement wallet can handle, especially after buying gifts for sixteen grandchildren. Balancing his qi will mean balancing his checkbook, so he and Yolanda begin collecting Social Security. Their modified adjusted gross income –MAGI (including their Social Security income)– is less than $150,000; therefore, as they are both age 65 or older, they may claim a personal exemption deduction of $12,000 on their tax return.
The purpose of this provision is clear.
While this provision does not “end tax on Social Security benefits”, it will help to offset some of the taxes paid on Social Security benefits by those seniors who rely on Social Security as a primary source of income.
This new deduction is effective for the 2025 tax year.
No Tax on Tips – Qualified Tip Deduction
Tips (that are reported) are not tax free.
This has not changed.
Instead, OBBBA created a new deduction of up to $25,000, effective 2025, for taxpayers who receive qualified tips.
These sorts of employees may be able to effectively exclude up to $25,000 of taxable tip income, reported via Form W-2, 1099-K, or 1099-NEC, from income tax. However, this is subject to significant fine print.
Limitations
- “Qualified tips” come from “qualified professions”
The Secretary of the Treasury is responsible for providing a list of professions that qualify. This list has not yet been released, but we may assume it will contain the usual suspects (restaurant servers, hair and beauty workers, food delivery drivers, etc.).
- A phaseout of the deduction for taxpayers above certain adjusted gross income (AGI) levels (discussed below).
- The taxpayer must have a valid Social Security number issued by the due date of their tax return to qualify for the deduction.
- If the taxpayer is married, the taxpayer must file a joint return.
- If the tips are received by a self-employed taxpayer, the deduction can only be claimed to the extent that the taxpayer’s gross income from the trade or business (including the tips) exceeds the sum of the taxpayer’s other deductions.
Example
In 2026, Mike decides that one year of retirement has been far too relaxing, and so he opens a dog training business, “Hot Dogs”. He receives $100,000 in gross income from the business, $20,000 of which are from tips. Because his business is new, he also has $85,000 in expenses. Because his income from the business after his other deductions is only $15,000, the deduction for his tips is limited to $15,000.
However, in 2027, Mike’s dog business is booming. He earns $100,000 plus another $25,000 in tips for a total of $125,000 in gross income. He still has $85,000 in expenses. These expenses are deducted against his gross income ($125,000 – $85,000=$40,000). Mike can deduct another $25,000 for his tips.
It is also important to underscore that reported tips are always subject to Social Security and Medicare withholding.
Phaseout
The deduction is phased out by $100 (or 10%) for each $1,000 by which a single taxpayer’s modified adjusted gross income (MAGI) exceeds $150,000 ($300,000 if married filing jointly) and completely phases out when the taxpayer’s MAGI reaches $400,000 ($550,000 if married filing jointly). See Example 3.
Example
After tricking another son-in-law into taking over the dog training business, Mike takes a job waiting tables at Clearman’s for the employee discount. He makes $10,000 in tips while waiting tables at the beginning of 2028. After serving Martin Scorsese a cheesy baked potato, he is discovered and lands a starring role in Scorsese’s newest film. He earns $315,000 for his impeccable performance. He has a MAGI of $325,000 ($10,000 in tips + $315,000) for 2028. Because his income is $25,000 above the threshold, he must reduce his deduction for his tips by $2,500 (10% × $25,000). So, $10,000 – $2,500 = $7,500, which is what Mike deducts.
No Tax on Overtime – Qualified Overtime Compensation Deduction
Overtime pay has always been reported as taxable income.
This has not changed.
However, OBBBA has created a new deduction of up to $12,500 ($25,000 for a married couple filing jointly) for taxpayers who receive overtime. This provision is effective for the 2025 through 2028 tax years.
Overtime is “qualified compensation” paid for time beyond 40 hours per week for nonexempt employees working on an hourly basis. The overtime must be reported on your W-2 to qualify for the deduction.
This will be a new version of the form, as previous iterations of the W-2 have not separately reported overtime earnings. Employers will now be required to prepare separate accounting for all the qualified overtime compensation hours worked by each employee.
As with the qualified tip deduction, there is fine print.
- Phaseout
Like the deduction for tips discussed above, the deduction is phased out by $100 (or 10%) for each $1,000 by which the taxpayer’s MAGI exceeds $150,000 ($300,000 MFJ) and completely phases out when the taxpayer’s MAGI reaches $275,000 ($550,000 MFJ).
Example
After finishing his movie, Mike decides that a life of fame and fortune isn’t for him (plus, he missed that employee discount at Clearman’s), and so he goes back to waiting tables. In addition to a base pay of $300,000, he earns $10,000 in tips and $20,000 in overtime pay. His MAGI is $330,000, which is $30k over the limit; his deductions (both for tips and overtime) are reduced by 10% of the excess ($30,000 x 10% = $3,000). Mike’s tip deduction is $7,000 ($10,000 – $3,000), and his overtime deduction is $17,000 ($20,000 – $3,000).
- Social Security Number Requirement
A taxpayer claiming the deduction must have a Social Security number issued by the due date of the taxpayer’s income tax return.
Please note that qualified overtime compensation is always subject to Social Security and Medicare withholdings, and once again, the deduction does not mitigate this.
No Tax on Auto Interest – Qualified Auto Interest Deduction
I do not know what “no tax on auto interest” means. Suffice it to say that this is inaccurate (and nonsensical).
OBBBA has created a deduction for qualified vehicle interest paid or accrued during
the taxable year on vehicle loans incurred after December 31, 2024. The loan must be an original loan to acquire the vehicle and must be secured by the vehicle. Refinances of the vehicle’s original acquisition debt also qualify. The deduction is only available for the 2025 through 2028 tax years and only for vehicles purchased for personal use.
Up to $10,000 in qualified auto interest may be deducted per taxable year, subject to the following limitations:
- The deduction is capped at $10,000 regardless of how many vehicle loans are taken out.
- The deduction is phased out by $200 (or 20%) for each $1,000 (or portion thereof) by which the taxpayer’s MAGI exceeds $100,000 ($200,000 for MFJ). This means that taxpayers whose MAGI is $150,000 ($250,000 MFJ) cannot claim this deduction.
- Taxpayers can only claim the deduction for the vehicle loan interest if the vehicle’s final
assembly occurs in the United States.
Example
Since Mike has done so well in his retirement, his wife Yolanda decides that it’s finally time to ditch that old Nissan she’s been driving for the last 30 years. She gets a loan for a brand-new Cadillac. The loan is $300,000 with an interest rate of 6%, meaning she is paying $18,000 in annual auto interest. She wants to deduct the first $10,000 per OBBBA, but Mike’s Hollywood career and food service endeavors have pushed their MAGI above $250,000. Sadly, they cannot deduct any interest paid.
Closing
I hope that this memo clarifies these new tax provisions.
We are pleased to assist you in claiming all applicable new deductions on your returns!
Kind Regards,
Leo Kanzelberger, CPA