Indiana lawmakers gave final approval Wednesday to legislation eliminating state and county income taxes on tips and overtime pay earned during 2026, aligning with federal tax relief provisions that took effect this year. The measure also exempts up to $10,000 in interest on loans for U.S.-assembled vehicles and introduces mandatory rounding for cash transactions starting in 2027.
Senate Enrolled Act 243, sponsored by state Sen. Travis Holdman, R-Markle, passed the House 77-19 in a bipartisan vote and now awaits final Senate concurrence. The one-year tax break will apply when Hoosiers file their 2027 returns, with the state’s 2027 legislature deciding whether to extend the provisions beyond 2026.
“This legislation is about making sure Hoosiers keep more of what they earn,” Holdman said. “By aligning Indiana’s tax code with the federal tax relief efforts, we’re able to provide hardworking Hoosier families with meaningful tax relief.”
The Revenue Impact
The nonpartisan Legislative Services Agency projects the tax changes will reduce state and local government revenue by up to $237 million. Tips deductions account for $96 million to $154 million of that total, with overtime exemptions contributing $45 million to $54 million and vehicle loan interest deductions adding roughly $30 million.
Indiana will cover the revenue shortfall by tapping its reserve accounts, which currently hold approximately $2 billion and are projected to grow to $5 billion by June 30, 2027. Holdman characterized this approach as part of Indiana’s “record of responsible fiscal accomplishments,” noting the state’s strong fiscal position allows for targeted relief without service cuts.
The federal One Big Beautiful Bill Act, signed in 2025, introduced the tips and overtime provisions that run through December 31, 2028. Indiana’s conformity applies only to the 2026 tax year, creating a one-year window for eligible workers to benefit from both federal and state exemptions.
Who Qualifies and How Much They Save
The tips deduction applies to workers in 68 occupations across eight categories, including food and beverage servers, bartenders, casino dealers, hairdressers, and other positions that customarily received tips before 2025. Workers can deduct up to $25,000 in tip income, though the benefit phases out for individuals earning above $150,000 in modified adjusted gross income or $300,000 for joint filers.
According to the Economic Policy Institute, eligible workers save an average of $1,400 under the federal tips provision. Indiana’s state conformity adds additional savings by eliminating the state’s 3.05 percent income tax and varying county income taxes on those earnings.
The overtime exemption covers all overtime pay earned during 2026, providing relief to workers across industries from manufacturing to healthcare who regularly work beyond 40 hours per week. Treasury Secretary Scott Bessent said Americans will receive “gigantic” refunds in 2027 due to these combined provisions.
Tyler Marshall, a worker from Chandler, Indiana, welcomed the changes. “I’m glad common sense is making its way back into policy,” Marshall said. “If the state needs more money, it should come in other ways besides the people putting in extra for their families.”
Rounding Down for the Penny Shortage
The legislation includes a separate provision requiring most cash-based tax transactions to be rounded down to the nearest five-cent increment beginning January 1, 2027. The requirement responds to penny shortages caused by the U.S. Mint’s decision to end one-cent coin production in November 2025.
State Rep. Jeff Thompson, R-Lizton, who championed the rounding provision in the House, said businesses retain flexibility in how they handle cash transactions. “If they round up, they may face customer blowback,” Thompson said. Government agencies, however, must round down on all cash payments including sales taxes, fees, and fines.
The rounding requirement could cost state and local governments millions in sales tax revenue and thousands in fees and fines, though precise estimates remain uncertain. Similar voluntary rounding policies exist in states like Wisconsin, but Indiana’s mandate represents one of the first statewide requirements tied to the federal penny phase-out.
Political Divisions Over Scope
Not all lawmakers supported the measure. State Rep. Greg Porter, D-Indianapolis, argued the tips provision disproportionately benefits higher earners while excluding many blue-collar workers who don’t receive tips. “In local government, that’s not walking around money, that’s survival money,” Porter said, referring to the revenue impact on municipalities.
State Rep. Jack Jordan, R-Bremen, pushed for broader relief. “I love tax cuts,” Jordan said, advocating for extending benefits to dishwashers, gas station workers, and other non-tipped employees who also work overtime.
The debate reflects national criticism of the federal tips policy, which excludes non-tipped workers despite similar income levels. Workers earning below the federal tax threshold see limited benefit from the federal provision, though Indiana’s state conformity extends some savings to lower-income tipped workers who still pay state and county taxes.
What Happens in 2027
The 2027 General Assembly will decide whether to extend the tax exemptions beyond 2026 or require Hoosiers to pay state and county income taxes on tips and overtime for subsequent years. The federal provisions remain in effect through 2028, creating a potential mismatch if Indiana doesn’t act.
Workers should track their 2026 tip and overtime earnings carefully to maximize deductions when filing 2027 returns. Employers must report these amounts according to federal requirements, with enhanced cash tip reporting standards taking effect in 2026. Eligible workers may need to file additional state schedules to claim the deductions, similar to federal Schedule 1 requirements.
Those who don’t adjust their 2026 withholding may see larger refunds in 2027, while others could face underpayment penalties if insufficient taxes are withheld. Tax preparation software is expected to incorporate the new state provisions for 2027 filing season.
Businesses accepting cash payments should prepare to update point-of-sale systems for the 2027 rounding requirement, balancing customer expectations against revenue impacts. Local governments face potential budget pressures from both the tax exemptions and rounding mandate, with some municipalities likely to adjust fees or seek other revenue sources to compensate.
Source
Indiana Adopts No Tax on Tips, Overtime Only for 2026 Tax Year | CPA Practice Advisor