The One Big Beautiful Bill Act (OBBBA) created deductions for qualified overtime and tips, effective from 2025-2028. While these provisions impact individuals, it is key for employers to provide accurate reporting for tips and hours worked.
“No Tax on Tips”
Employees and self-employed individuals may deduct up to $25,000 in qualified tips received in occupations that traditionally and regularly receive tips as of December 31, 2024 (phaseout starting at $150,000/MAGI / $3000,000 jointly). Tips must be reported on a Form W-2, Form 1099, or other specified statement furnished to the individual or reported directly by the individual on Form 4137.
“No Tax on Overtime”
Individuals who receive qualified overtime compensation may deduct the pay that exceeds their regular rate of pay that is required by the Fair Labor Standards Act (FLSA), up to $12,500 (phaseout starting at $150,000/MAGI / $3000,000 jointly). Overtime compensation must be reported on a Form W-2, Form 1099, or other specified statement furnished to the individual.
What does this mean for the 2025 tax year?
Employers will not begin reporting separate amounts for qualified tips and overtime pay until 2026. In the meantime, employers should continue to keep detailed records of tips and time worked. For tax year 2025, the IRS has released temporary rules for claiming the deductions. According to Notice 2025-69, taxpayers may utilize alternative documentation for 2025.
Other employer considerations
“No Tax on Tips”
There are exceptions to the tip deduction. Automatic service charges and gratuities implemented by the service provider are likely not eligible for tax deduction for “qualified tips.”
“No Tax on Overtime”
Under the FLSA, the “qualified overtime” deduction applies only for weekly overtime. Employers will need to have a method of identifying weekly overtime on W-2s. The FLSA considers overtime to be more than 40 hours per week, although some states have daily overtime requirements that are greater than federal law. Withholding procedures will also need to be adjusted, beginning this year.
Next steps
Some employers may feel inclined to reclassify non-exempt employees to exempt to avoid the hassle of reporting overtime. However, this may cause issues, as there are several guidelines in place that dictate the classification of employees.
HR should clearly inform employees of the deduction limits, as the deductions do not apply to all tips or overtime, and only apply to federal income taxes. Social Security, Medicare, and other federal payroll taxes will continue to apply to all wages.
Check with your payroll provider that time tracking and pay stub reporting are error-free and adhere to legal requirements. Employers who do not implement proper reporting systems are at risk of violating laws that require employers to provide accurate pay stub information.
Managing compliance in a rapidly evolving legal environment can be complex. Lever1 is here to support you. Our HR and compliance experts provide guidance to keep business owners informed of new laws and policies, reducing your risk while saving you time. Our advanced time tracking and payroll processing system ensures that your records are accurate and compliant.