REAL AMERICA Act Proposes Tax Deductions for Tips & Overtime, Ends Social Security Tax, Targets Carried Interest

The REAL AMERICA Act aims to reshape parts of the U.S. tax code, offering new deductions for workers earning tips and overtime, eliminating taxes on Social Security benefits, and significantly changing how income from investment management services is taxed. Key provisions include creating tax breaks for specific types of compensation for those earning under $450,000, repealing the taxation of Social Security income starting in 2026, and immediately altering rules around partnership interests, particularly targeting 'carried interest'.

More Take-Home Pay for Tipped and Overtime Workers?

Starting in taxable years after December 31, 2025, this bill introduces two new potential tax deductions. First, cash tips reported to an employer (under 26 U.S. Code § 6053(a)) could be deducted from gross income (Section 2). Second, 'qualified overtime compensation' – essentially pay for hours worked over 40 per week at a rate higher than the regular rate, as defined by Section 7 of the Fair Labor Standards Act – could also be deducted (Section 4).

There's a catch: these deductions phase out for higher earners. Neither deduction is allowed if a taxpayer's modified adjusted gross income (MAGI) exceeds $450,000. For those who qualify, these deductions would be available even if they don't itemize, potentially lowering the tax bill for many servers, bartenders, construction workers, and others who rely on tips or regularly work overtime. The bill requires employers to report qualified overtime on W-2 forms (amending 6051(a)) and directs the Treasury to adjust tax withholding tables to account for these new deductions.

Social Security: Tax-Free Starting 2026

Currently, depending on overall income, a portion of Social Security benefits can be subject to federal income tax under Section 86 of the tax code. This bill proposes to completely repeal Section 86, meaning Social Security benefits would no longer be included in gross income for tax purposes (Section 3). This change would apply to taxable years beginning after December 31, 2025. To address potential funding shortfalls caused by this lost tax revenue, the bill also appropriates funds directly to the Social Security and Railroad Retirement trust funds.

Shaking Up Partnership Taxes & Carried Interest

The Act introduces immediate changes for partnerships. Section 5 alters how partnership interests transferred for services are valued (based on hypothetical liquidation value) and taxed, creating a default assumption that the value is included in income upon transfer unless the recipient specifically elects out under rules similar to the existing Section 83(b)(2).

More significantly, Section 6 takes aim at 'carried interest' – the share of profits investment managers often receive. It creates a new Section 710 in the tax code, effectively recharacterizing most net capital gains derived from an 'investment services partnership interest' (ISPI) as ordinary income. This means income that might currently be taxed at lower long-term capital gains rates would instead be taxed at higher ordinary income rates. This applies to partners providing services like investment advice or asset management. The bill defines ISPIs and investment partnerships, disallows certain favorable treatments (like qualified dividends or Section 1202 small business stock exclusions) for income tied to ISPIs, and treats gains from selling an ISPI as ordinary income. It also explicitly includes this income in the calculation for self-employment taxes (amending Section 1402(a)) and repeals the existing, less stringent Section 1061 related to carried interest. These changes generally apply to tax years ending after the bill's enactment date and include a hefty 40% penalty for underpayments related to avoiding these rules (amending Section 6662).

The Bottom Line

The REAL AMERICA Act bundles potential tax relief for specific groups – tipped workers, overtime earners (under the $450k income cap), and all Social Security recipients – with a major overhaul targeting the taxation of investment managers. While the worker and retiree benefits kick in for 2026, the complex changes to partnership and carried interest taxation would take effect much sooner, potentially altering the financial landscape for private equity, hedge funds, and other investment partnerships.