New Overtime and Tip Deductions Available, Not for California Workers
Beginning in 2025, federal tax law provides new deductions aimed squarely at working taxpayers who earn tips or overtime pay. These provisions were enacted as part of the One Big Beautiful Bill Act and were designed to reduce taxable income for service and hourly workers nationwide. California has chosen not to conform to these federal changes. As a result, California workers receive a federal tax benefit that is fully reversed on their California return, not because of federal law, but because of California law.
Key Tax Impacts for California Workers
- Federal law allows deductions for qualified tips and qualified overtime compensation for tax years 2025 through 2028.
- California does not allow either deduction under state law.
- Tip income and overtime pay remain fully taxable for California personal income tax purposes.
- California taxpayers must add back these deductions on Schedule CA.
- The denial of these deductions disproportionately affects working class Californians.
What Federal Law Allows
Under federal law, new IRC §224 permits an above the line deduction for qualified cash tips, and new IRC §225 permits a similar deduction for qualified overtime compensation required under the Fair Labor Standards Act. These deductions are available regardless of whether a taxpayer itemizes and are subject to income based phaseouts. For many workers, these provisions reduce federal taxable income by thousands of dollars.
For 2025, the IRS issued Notice 2025-69 to address delayed payroll reporting changes. This guidance allows workers to use reasonable records, including pay stubs, employer statements, and contemporaneous logs, to substantiate eligible tips and overtime premiums.
Why California Does Not Allow the Deductions
California’s denial of these deductions is not driven by federal restrictions. It is the direct result of California’s selective and static conformity to the Internal Revenue Code. California must affirmatively adopt federal tax law changes, and the One Big Beautiful Bill Act was enacted after the state’s most recent conformity update.
State budget and legislative analyses indicate that conforming to the new tip and overtime deductions would reduce California revenue by an estimated $3.2 billion per year. California leadership has signaled no intent to adopt these provisions, preferring to preserve funding for public programs. The impact of this decision falls primarily on working Californians whose income consists of tips or overtime pay.
Practical Impact on California Returns
For California personal income tax purposes, there is no exclusion or deduction for qualified tips or qualified overtime compensation. Taxpayers who properly claim these deductions on their federal return must reverse them when preparing their California return. This is done through an upward adjustment on Schedule CA for both Form 540 and Form 540NR.
In practical terms, many California workers will see a lower federal tax bill but little or no reduction in their California tax liability. This disconnect often creates confusion when preparing a California return and can lead to unexpected balances due at the state level.
Final Takeaway
The new federal deductions for tip income and overtime pay were intended to benefit working taxpayers. California’s decision not to conform means those benefits largely stop at the state line. For California workers, a higher state tax bill is the result of California law, not federal policy. Understanding this distinction is essential for accurate tax planning and avoiding surprises at filing time.
