Latest / VoraPrep Audio — Professional Licensure & Certification Exam Prep / [CPA] TCP: Post-OBBBA Individual Tax Planning: Mastering the New Income Exclusions
Transcript
- Hey, welcome to VoraPrep Audio. Thanks for tuning in. So, let's talk about a change that's going to be a huge deal for your future clients, and definitely for your exam. Imagine your client is a server at a busy restaurant. They do really well, reporting $28,000 in tips for the year. Before 2026, every single dollar of that was taxable income. Every one. But now, under a new set of rules, a massive chunk of that—$25,000—is completely tax-free. This isn't just some small adjustment. It's a fundamental shift. The law that did this, the Omnibus Budget and Bipartisan Benefits Act, or OBBBA for short, basically created a new 'tax-free zone' for specific kinds of income that people work really hard for. For us as CPAs, knowing these rules inside and out isn't just about getting a question right. It's about being able to deliver some serious value. First, let's set the stage. You might remember the Tax Cuts and Jobs Act, the TCJA, from back in 2017. It made a lot of big changes to individual taxes, but many of them were temporary. They were set to expire after 2025, creating this sort of 'sunset cliff' that made long-term planning tricky. Well, OBBBA came in and provided some much-needed stability. It took some of the most important TCJA provisions and made them permanent. We're talking about things like the 20 percent Qualified Business Income deduction—QBI—under Section 199A, and the enhanced Child Tax Credit, which is now set at $2,200. Permanence. That means we can actually create multi-year strategies for our clients without wondering if the rules will suddenly change. Okay, so with that stability in place, OBBBA then introduced these brand new exclusions. The first one is for tip income. This is under the new Internal Revenue Code Section 224. For any tax year starting in 2026, a taxpayer can exclude up to $25,000 of their tip income from their gross income. And it’s an above-the-line deduction. That’s huge because it directly lowers their Adjusted Gross Income, their AGI, before they even start thinking about standard or itemized deductions. It’s a direct hit to their taxable income. Now, one thing to be careful about is that this is for employee tips. It doesn't apply to those automatic service charges that some restaurants add on—the IRS just treats those as regular wages. Here’s a quick check on how the limit works. Say your client has two part-time server jobs. They earn $15,000 in tips from the first job and another $15,000 from the second. That’s $30,000 total. How much can they exclude? The answer is $25,000. That limit is per taxpayer, not per job. So, they’ll still have $5,000 of taxable tip income. The other major new exclusion is for overtime pay. This is another big one. Before, every dollar of overtime was fully taxable, just like regular wages. But for 2026 and later, any compensation for hours worked beyond a standard 40-hour workweek is now excludable from gross income. And here's the key difference you have to remember: unlike the tip exclusion, there is no dollar cap on this. None. If a non-salaried employee works enough overtime to earn an extra $10,000, or $20,000… all of it is excludable. Just like the tip exclusion, this is also an above-the-line deduction that lowers AGI. So when you see a question on the exam about this, here’s how to approach it without getting tangled up. First, always check the tax year. If the question says 2025, none of this applies. It has to be 2026 or later. That’s the gatekeeper. Next, you need to break down the client's income. The fact pattern will give you different components. Pull them apart: what are the regular wages, what’s the overtime pay, and what’s the tip income? Be a detective here. Then you apply the rules, one at a time. For the tips, you take the lesser of their total tip income or that $25,000 statutory limit. That’s your excludable amount for tips. After that, you look at the overtime pay. How much is it? Whatever the number is, that’s your exclusion. The whole thing. And finally, you put it all together. Start with their total gross income—all their earnings added up. Then subtract the tip exclusion you calculated, and subtract the full overtime exclusion. What’s left is their final AGI. Let’s walk through one together. Let's say we have Ava, a single lead server, and we’re looking at her 2026 tax year. Her pay consists of three parts: regular wages of $40,000, overtime pay of $8,000, and reported cash tips of $28,000. We need to find her AGI. Okay, first step, let's find her total gross income before any of these new breaks. We just add it all up: $40,000 in wages, plus $8,000 in overtime, plus $28,000 in tips. That gives us a starting point of $76,000. Now for the exclusions. Let's start with the tips. Ava made $28,000 in tips. The rule says she can exclude the lesser of her total tips or the $25,000 limit. So, her exclusion is $25,000. The other $3,000 is still taxable. Next, the overtime. She earned $8,000 in overtime pay. What’s the rule here? There's no cap. So, the entire $8,000 is excludable. So, her total exclusions are the $25,000 from tips plus the $8,000 from overtime, which is $33,000. Last step, we calculate her AGI. We take her gross income of $76,000 and subtract her total exclusions of $33,000. And that leaves us with an AGI of $43,000. Now, if you were working this problem and got an answer of $51,000, you fell for the exact trap the exam writers would set. You would get that number if you correctly excluded the $25,000 for tips… but completely forgot to also exclude the $8,000 of overtime. OBBBA gives us two new, separate exclusions. You have to check for both. The main place people can get twisted is in mixing up the limits. So just remember this simple difference: Tips have a cap. It's a hard cap of $25,000 a year. Overtime has no cap. All of it is excludable. Keep that straight, and you’ll be in great shape. If you need a simple way to keep the big individual changes from OBBBA straight in your head, just think of the word "TOP" T is for Tips, with that $25,000 exclusion. O is for Overtime, where all of it is excluded. And P is for Permanence, reminding you that key TCJA rules like QBI and the Child Tax Credit are now permanent. TOP. Of course, remembering little mnemonics and walking through practice questions is what it's all about. If you want more of this, VoraPrep is a full exam-prep app with lessons, thousands of practice questions, and an AI tutor to help you work through concepts like this. You can check it out and get started for free at Vora Prep dot com. Just one last exam-day thought on this. When you get a question with a breakdown of someone's pay, read those labels like a hawk. The AICPA will test if you can tell the difference between 'base salary,' 'tips,' 'gratuities,' and 'overtime.' If the prompt just says 'total wages of $50,000,' you can't assume anything. You can only apply the exclusions to amounts that are explicitly called out as tips or overtime. So, to wrap it all up: OBBBA is a big deal for 2026 and beyond. It gives us a $25,000 exclusion for tips, an unlimited exclusion for overtime, and it made really important parts of the TCJA permanent. Both of these new exclusions are above-the-line, which is fantastic for lowering a taxpayer's AGI. Alright, that's it for this one. Keep up the great work. You're getting closer every day. I'll talk to you next time.