How will North Carolina’s tax code treat the federal tip and overtime deductions for tax year 2026 and beyond?
Executive summary
North Carolina does not yet have a settled answer: Congress’s “One Big Beautiful Bill” created federal above‑the‑line deductions for qualified tips and qualifying overtime effective for tax year 2025 (claimed on 2025 returns filed in 2026), employers and the IRS are implementing new reporting rules beginning in tax year 2026, and North Carolina lawmakers introduced legislation (House Bill 11) to mirror the federal carveouts but had not completed action as of late 2025—so whether the state will exempt those amounts for 2026 and beyond depends on forthcoming state legislative decisions and conformity choices [1] [2] [3] [4].
1. What the federal change actually does and how reporting will shift
The federal law creates two new above‑the‑line deductions—one for “qualified tips” and one for “qualified overtime compensation”—applicable for tax years 2025–2028, with IRS guidance and transition relief shaping how amounts are reported and claimed; employers must separately report qualified tips and overtime on Form W‑2 starting for tax year 2026 to enable employee claims, though withholding and FICA continue to apply [1] [5] [6] [7].
2. North Carolina’s legislative posture and the simple legal question
North Carolina has a clear legislative vehicle to adopt the federal carveouts—House Bill 11 explicitly titles itself “No Tax on Tips, Overtime, Bonus Pay” and seeks to exempt tips, overtime and some bonuses under state law—but reporting in late 2025 and into early 2026 shows the bill was proposed, not universally enacted, meaning the state’s tax code treatment hinges on whether lawmakers pass decoupling language or leave the state’s conformity rules unchanged [3] [4].
3. Practical implications for taxpayers filing 2026 returns
If North Carolina enacts decoupling language like HB11, tip and overtime deductions claimed federally for 2025 (filed in 2026) could also reduce North Carolina taxable income in tax year 2026 and beyond; if the state does not act, the result depends on North Carolina’s conformity approach—some states automatically track the federal change, others require an add‑back—so taxpayers should be prepared for either outcome and expect employers’ payroll reporting to include separate tip/overtime detail for 2026 W‑2s [2] [5] [4].
4. Political and fiscal fault lines: who benefits and who pays
Advocates argue the carveouts help low‑paid tipped workers and overtime earners; fiscal analysts and groups like the Institute on Taxation and Economic Policy warn states that mirror the federal deductions face meaningful revenue losses (ITEP estimated sizable state revenue impacts for states that conform), while tax policy groups caution about distortionary targeting versus broad, neutral relief such as rate cuts or larger standard deductions—North Carolina’s own policy debate mirrors that national split, with proponents seeking targeted relief and opponents warning about budgetary strain and unequal treatment of workers [8] [9] [1].
5. What employers, preparers and taxpayers should watch now
For tax year 2026 and beyond, employers will have new W‑2 reporting obligations and taxpayers will be able to use revised W‑4 worksheets to adjust withholding for expected qualified tips and overtime, but whether those federal deductions lower North Carolina taxable income depends on whether the legislature passes HB11 or another conformity decision; the Department of Revenue guidance and the General Assembly’s 2026 session outcomes are the proximate signals to watch [5] [7] [3].
Bottom line
As of the available reporting, North Carolina has proposed to exempt tips and qualifying overtime from state income tax and could treat the federal deductions as non‑taxable at the state level if lawmakers adopt HB11 or equivalent statutory language, but until the legislature acts (or the state’s conformity rules are updated) there is no unilateral administrative change guaranteeing that federal tip and overtime deductions will reduce North Carolina taxable income for 2026 and beyond [3] [4] [2].