The 2025 Tax Breaks - Follow Up

One of the Republican talking points as we progress to the next phase of the never-ending election season is that Americans have benefitted from Republican leadership in the form of larger-than-usual tax refunds. 

The size of your tax refund is a not-very-accurate method of determining whether any tax law was or was not beneficial to you. Unless you qualify for tax credits like the Earned Income or Child Tax Credits, or tax credits derived from Tax Incentives programs, your tax refund will consist of taxes that you overpaid during the year. It is effectively an interest-free loan to the government. (Line 24 on Form 1040, is where your actual tax is listed.) This year (2025 tax year, filed in 2026) was different. There were three major tax deductions that affected lower-to-middle income taxpayers.  

Let's start with Social Security, and how portions of it are taxed now. First of all, not all Social Security benefits are taxed. For a taxpayer filing singly, if total adjusted gross income plus half of social security benefits is $25,000 or greater, then up to 50% of benefits count as taxable income. If the total is greater than $34,000, then up to 85% of benefits count as taxable income. (The exact percentage is a sliding scale — the formula can be found in the Form 1040 instructions). For married couples filing jointly the thresholds are $32,000 and $44,000. So whether someone's Social Security benefits are taxable or not is based entirely on whether their combined income exceeds the levels mentioned above. 

If the formula indicates that a portion of one's benefits will be taxed, this is not deducted from their monthly benefits, but is calculated when completing the annual tax forms and determines tax liability, and therefore either the refund or amount due. 

The new tax law does not eliminate taxes on Social Security benefits. What it does is provide an additional deduction for seniors (age 65+) of $6,000 per individual ($12,000 for married filing jointly). In other words, it reduces taxable income by these amounts. This phases out for individuals earning more than $75,000 or married filing jointly over $150,000. This reduces the number of  seniors who will have their benefits taxed, but does not eliminate the tax itself. For example an individual who is still working with combined adjusted gross income and half of benefits exceeding $31,000 (the statutory threshold plus the new deduction) will have some of her Social Security benefits taxed. 

This additional deduction is only in effect for four years. It will also hasten the insolvency of the Social Security Trust Fund, since taxes on benefits go back into the Trust Fund. This additional deduction is for all seniors, not just those who are receiving Social Security benefits. 

Next up: tips

Tips are taxable income, the same as any other source of income like W-2 or 1099 remuneration. The only reason it appears to be tax-free is that many people who receive tips do not report them as income unless compelled to do so by their employer. It's virtually impossible for the Internal Revenue Service (IRS) to track every tip paid in cash (i.e. not by credit or debit card). The IRS has attempted to make it more difficult for employees to avoid paying taxes on their tip income by holding their employers accountable. Currently, in a business with tipped employees, the employees are required to report all tips to their employer who will include those tips as part of their gross income, and withhold federal and state taxes, as well as Social Security and Medicare taxes. Since it's possible that not all tips will be reported, the business is required to calculate what reported tips would be if they equaled 8% of sales. If total reported tips fall below 8%, the business is then required to allocate the difference between actual reported tips and 8% among all tipped employees. (Not sure if this allocation is based on sales or hours — nothing prevents an employer from having a stricter policy). This results in a tipped employee being taxed for income that they may or may not have actually received.  

The new law does not eliminate taxes on tips. What it does do is allow workers in "occupations that customarily and regularly received tips" to deduct $25,000 in tipped income from their taxable income. (This clause is supposed to prevent people who don't receive their income from tips to classifying their fees as "tips" and avoiding some taxes. With all the cuts in IRS staffing, I'm sure there will be abuses.)  All tips above $25,000 are taxable. One recurring misunderstanding is that this deduction applies only to tips paid in cash. The IRS defines "cash tips" as tips paid in cash, check, card etc. The definition of "cash tips" excludes in-kind gratuities or services in lieu of cash. This change will not benefit low income workers if their total income was already below the standard deduction, but it will reduce taxable income for many tipped workers. 

Expires after four years. 

Finally: overtime

This is similar to tips in that overtime pay is still taxable, but that a portion can be deducted from taxable income. Individuals can deduct $12,500 and married couples filing jointly can deduct $25,000. This deduction only applies to the "and a half" portion of "time and a half" paid for overtime hours. 

Expires after (you guessed it) four years. 

The bill requires that the IRS formulate regulations to govern withholding for both tips and overtime by 2026. For the portion of 2025 after this law as passed taxes continued to be withheld as before. This caused the withholding to be greater than it should have been, which is partly why refunds are greater this year. 

How will this affect state taxes? This remains to be seen. For Nebraska, taxable income is mostly based on federal adjusted gross income with a few Nebraska-specific adjustments. (Nebraska already completely exempts Social Security benefits from state income tax.) So, if these deductions reduce federal taxable income, will it also affect state taxable income? States can adjust their tax codes to compensate, or they can go along with the federal regulations; although Nebraska's legislature is out of session for the year. It looks like I got out of the Nebraska Department of Revenue just in time. FICA withholding will continue to be based on an employee's gross wages, so tips and overtime will still be subject to FICA. 

Nebraska LB 30 makes tips & OT deductible for NE income tax — still in committee

For someone whose marginal tax rate is 12% claiming the full $12,500 deduction for overtime, they'll see a reduction in taxes of $1,500. Tipped workers who claim the full amount will see their taxes reduced by $3,000. Seniors will see a $720 drop in taxes. All of these amounts are deductions from the adjusted gross income and not credits. If they exceed what taxes would have been otherwise, it doesn't generate a credit. Zero is as low as you can go! How does this affect refunds? 

Withholding tables were scheduled to be adjusted starting January 1, 2026, which should eliminate the larger refunds that many people saw this year. All overtime and tipped income is also still subject to Social Security and Medicare taxes. 

 All of these deductions expire in four years unless extended by Congress. So, the Republicans aren't lying when they say that the 2025 tax law has benefitted many Americans. Theoretically it has.