The One Big Beautiful Bill Act (OBBBA) introduces significant but temporary changes affecting how tips and overtime income are taxed. While these new tax breaks provide relief for many employees, they also add new layers of complexity for employers, payroll processors, and tax professionals managing compliance.
New Deduction for Tip Income
From 2025 through 2028, qualifying workers can claim a temporary federal income tax deduction of up to $25,000 annually for qualified tip income. The deduction phases out when modified adjusted gross income (MAGI) exceeds $150,000 for single filers or $300,000 for joint filers.
This deduction applies to individuals in occupations where tips are customary, as determined by the IRS. Surprisingly, the Treasury Department’s proposed list includes not only servers and bartenders but also plumbers, electricians, HVAC specialists, digital content creators, and home movers.
Professionals in industries such as healthcare, law, accounting, finance, and investment management are not eligible for this deduction.
Qualified tips may come from cash, credit card transactions, or tip-sharing programs, and the deduction is available regardless of whether taxpayers itemize deductions.
New Deduction for Overtime Income
The OBBBA also introduces a temporary overtime income deduction of up to $12,500 per year, or $25,000 for joint filers, during the same 2025–2028 period. The phase-out thresholds mirror those of the tip income deduction.
Under Section 7 of the Fair Labor Standards Act (FLSA), “qualified overtime income” refers to the additional half-time portion of overtime pay (the premium above regular wages). This means only the extra 50% portion of time-and-a-half pay qualifies for the deduction.
Excluded from this benefit are:
Overtime required solely by state laws,
Overtime premiums set by union or collective bargaining agreements, and
Any form of tip income.
Payroll Tax Implications and Common Misconceptions
Despite headlines claiming “no tax on tips” or “no tax on overtime,” these provisions are deductions—not income exclusions. As such:
Federal income tax may still apply to a portion of wages,
Payroll taxes (Social Security and Medicare) remain fully applicable to qualified tip and overtime income,
Federal income tax withholding rules are unchanged, and
State and local taxes may continue to tax all tips and overtime earnings in full.
For employers and payroll processors, the key challenge is maintaining accurate reporting and tracking to ensure workers can claim these deductions correctly.
Reporting Requirements
The tip income deduction applies to both employees and self-employed individuals. Qualified tip amounts must be properly reported using Form W-2, Form 1099-NEC, or another IRS-approved reporting form that’s furnished to both the worker and the IRS.
Similarly, qualified overtime income must be reported to employees on Form W-2 or a comparable information return. Proper reporting ensures compliance and allows employees to substantiate their deductions when filing returns.
IRS Guidance for 2025
The IRS recently confirmed that for tax year 2025, there will be no immediate updates to federal payroll or information reporting forms due to the OBBBA. That means Forms W-2, 1099, 941, and other payroll filings remain unchanged.
According to the IRS, this approach is meant to minimize disruptions during the upcoming tax season while giving employers, payroll processors, and tax professionals time to prepare for implementation in future years.
Next Steps for Employers and Payroll Departments
To prepare for these changes, employers should:
Start tracking qualified tips and overtime income immediately.
Implement systems to identify and record payments made before July 4, 2025, when the OBBBA was enacted.
Establish internal controls for retroactive adjustments; and
Monitor future IRS updates, which are expected to include transition relief for 2025 and revised reporting forms for 2026.
Early preparation will ensure compliance and accurate employee reporting under the new rules.
If you need help implementing compliant payroll systems or understanding how these new deductions affect your business, JCox CPAs & Advisors, P.C. can help you navigate the OBBBA’s provisions and ensure your payroll operations remain tax-efficient and audit-ready.
