As you may know, the One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, introduced two major provisions impacting payroll and tax reporting:
- “No Tax on Tips” Deduction: Employees in occupations that customarily and regularly receive tips may claim an above-the-line deduction of up to $25,000 in qualified tips from their taxable income.
- “No Tax on Overtime” Deduction: Employees may deduct up to $12,500 of qualified overtime compensation (or $25,000 for joint filers) from their taxable income. This applies only to the premium portion of overtime pay required under the Fair Labor Standards Act (FLSA).
What This Means for Employers
2025 Transition Relief: The IRS has announced that for tax year 2025, employers will not be penalized for failing to separately report qualified tips, qualifying occupations, or qualified overtime amounts on Forms W-2 or other statements. This is a transition year to allow businesses time to update systems.
Reporting Requirements Starting in 2026: Beginning with tax year 2026, employers will be required to report the total amount of qualified tips and the employee’s occupation code on Form W-2 and report the total amount of qualified overtime compensation separately.
Recommended Actions for 2025
To determine the qualified tips deduction, employees may use amounts from Form W-2 box 7 or Form 4070 (Employee’s Report of Tips to Employer), while non-employees can use records like daily tip logs. For the qualified overtime deduction, Fair Labor Standards Act (FLSA) eligible individuals can use reasonable methods, such as approximating the amount as one-third of total overtime compensation on a pay statement. The guidance also provides transition relief for the specified service trade or business (SSTB) rule, treating tips as eligible if the occupation customarily received them before December 31, 2024, pending final regulations. The guidance applies only to the 2025 tax year.
We have prepared a customizable letter that provides instructions for filing tax returns and specifies the information employees should use. It can be downloaded, customized and distributed to your employees either prior to, or together with, W-2 forms.
Additional Notes
- These deductions do not affect FICA taxes. Tips and overtime remain subject to Social Security and Medicare withholding.
- Mandatory service charges or auto-gratuities do not qualify as tips for the deduction.
- Employers should review payroll systems now to prepare for mandatory reporting in 2026.
If you have questions about these changes or need assistance updating your payroll processes, please feel free to contact us for additional information.