OBBBA 2025–2028: Tax Breaks for Tips and Overtime Pay

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Key Takeaways

• The One Big Beautiful Bill Act (OBBBA) introduces significant federal income tax deductions to individuals for qualified tips and overtime pay, effective 2025–2028.
• The new deductions target middle- and lower-income workers, with phase-outs for higher earners.
• Employers must adapt to new payroll and payee information reporting obligations, including occupation-specific disclosures.
• Compliance challenges are expected, especially in industries with complex compensation structures.
• The IRS and Treasury have issued guidance and transition relief to help businesses implement reporting changes and allow eligible workers to claim deductions.

Overview of OBBBA 2025–2028 and Its Purpose

On July 4, 2025, President Trump signed into law the One Big Beautiful Bill Act (OBBBA), ushering in sweeping tax changes that affect both individuals and businesses retroactively beginning January 1, 2025. The act extends and enshrines many prior tax-cut measures while layering in new provisions, including the much-discussed “No Tax on Tips” and “No Taxes on Overtime” rules, both slated to operate through 2028.

For employers, particularly those in the food and beverage services, personal services, hospitality, gaming, retail, transportation, manufacturing and construction sectors, these rules introduce significant administrative, compliance, and systems changes. While the deductions apply at the individual level, the burden falls largely on employers to ensure accurate information reporting, proper withholding, and alignment with current IRS and Treasury guidance.

Understanding Payroll Reporting Under the No Tax on Overtime Rule

Under OBBBA, employees may deduct the “qualified overtime compensation” they receive beyond their regular rate (i.e. the “half-time” premium portion of time-and-a-half) from federal income tax up to $12,500 for single filers (or $25,000 on joint returns) in a given year.

• FICA / Medicare still apply. Employers must continue to withhold Social Security and Medicare taxes on the full overtime pay, including the premium portion.
• Separate reporting required. Employers must make a separate accounting and report the amount of qualified overtime compensation on information returns (e.g., W-2s or other applicable statements) so that employees can claim the deduction.
• Employer Transition rules in 2025. For tax year 2025, the IRS announced that Forms W-2 will not be updated to reflect the new qualified overtime compensation reporting requirements. The primary reason cited by the IRS for not updating the forms for the 2025 tax year was that employers and payroll providers did not have enough time or the systems in place to track and report the specific data required by the OBBBA, which was enacted midway through the year. Therefore, the IRS has provided guidance (IRS Notice 2025-62) stating that tax year 2025 will be regarded as a transition period for purposes of IRS enforcement and administration of the new information reporting requirements for qualified overtime compensation. The IRS won’t require employers to separately account for qualified overtime compensation to individuals for 2025 and will not impose information reporting penalties for failure to report on Forms W-2, provided all other information is complete and correct. While not a requirement to receive the penalty relief provided, employers are encouraged to provide separate accountings of overtime compensation such that the employee recipient has the information needed to determine whether they can claim the deduction for qualified overtime compensation for the tax year 2025.
• Employee Taxpayer Transition rule in 2025. The IRS published separate guidance (IRS Notice 2025-69) instructing workers with alternative methods on how to determine the amount of their deduction for tax year 2025 in the absence of receiving a separate accounting from their employer. Beginning in 2026, more exact and standardized reporting will be required of employers, allowing workers to simply refer to their W-2 forms.
• System upgrades are likely needed. Payroll systems must be modified to isolate overtime premiums, store them in a separate reporting bucket, and produce reports compatible with new 2026 W-2 requirements.
• Potential ambiguity around “qualified.” Only overtime mandated under Section 7 of the Fair Labor Standards Act (i.e., pay for hours worked over 40 in a workweek at not less than one and one-half times the regular rate) qualifies. Voluntary overtime, premium payments under state law or collective bargaining agreements beyond FLSA requirements, or overtime-like bonuses currently do not qualify under the statute.
• Employee Eligibility. The deduction is available to both itemizing and non-itemizing taxpayers, but married individuals must file jointly to claim the higher joint deduction. The taxpayer’s Social Security Number must be included on the return.

Implementing New Tip Income Guidance: Recent Developments

The “No Tax on Tips” provision in OBBBA allows employees and self-employed individuals in qualifying tipped occupations to take an above-the-line deduction for up to $25,000 of “qualified tip” income (regardless of itemizing or not). The deduction phases out beginning at $150,000 of Modified Adjusted Gross Income (MAGI) ($300,000 joint) and expires after 2028.

• Defining qualifying occupations. Tips must be earned in industries or occupations that “customarily or regularly” received tips prior to December 31, 2024. The Treasury Secretary has issued proposed regulations (REG-110032-25) that provide a detailed list identifying nearly 70 separate occupations. For example, for restaurants this includes wait staff, bartenders, bussers, hosts, cooks, dishwashers, and other food service roles, provided they participate in tip-sharing arrangements [emphasis added].
• Electronic and cash tips included. Qualified tips include voluntary payments in cash, charged (card), or the same via tip-sharing arrangements (subject to reporting). Mandatory service charges, automatic gratuities, non-cash benefits (meals, lodging), illegal activities or tips received from a payor in which the recipient has an ownership interest or is employed, are not qualified tips and are excluded.
• Withholding and reporting. The new law does not relieve employers of income tax withholding on wages, including tips; they must separately identify qualified tips for deduction purposes.
• Employer tracking and record retention. Employers must continue to collect daily tip reports from employees, retain those records, and aggregate them into the separate “qualified tip” bucket for W-2 reporting. For 1099 payee statements to non-employees (for example rideshare or salon workers), payors must separately account for the portion of payments that have been designated as cash tips (includes cash, charged, and shared tips) and include the occupation of the individual receiving the tips. Self-employed individual tip recipients can rely on the information reported on their 1099, however, it is recommended they maintain their own detailed tip logs, receipts, and other support documentation in case of a discrepancy.
• Specified Service Trade or Business (SSTB) Exclusion. Tips received in the course of an SSTB occupation (i.e. specific fields where the principal asset involves the reputation or skill of one or more individuals such as health, law, accounting, financial services, athlete, actor) are not qualified tips. For employees, this is determined by whether the employer’s business is an SSTB.
• Employer and Other Payor Transition rules in 2025. The same IRS transition guidance provided in IRS Notice 2025-62 for qualified overtime compensation for the tax year 2025, also applies to qualified tips. Forms W-2 and 1099 will not be updated to reflect the new qualified tip and occupation reporting requirements. The IRS won’t require employers and other payors to separately account for qualified tips to individuals for 2025 or the occupation of recipients. Moreover, information reporting penalties will not be imposed for failure to report qualified tip and occupation data on Forms W-2 and 1099. Notwithstanding, employers and payors are still encouraged to provide separate accountings of tip income and occupation such that the employee or payee recipient has the information needed to determine whether they can claim the deduction for qualified tips for the tax year 2025. But again, this is not a requirement to receive the IRS penalty relief.
• Employee and Payee Taxpayer Transition rule in 2025. The separate guidance published in IRS Notice 2025-69 also directly addresses qualified tip deductions for tax year 2025. The guidance provides practical examples of how workers can use existing records and reasonable estimation methods to determine the amount of their qualified tip deduction, in the absence of receiving a separate accounting from their employer or non-employment payor. Additionally and until at earliest 2026, whether a trade or business is a SSTB for purposes of the qualified tip deduction and associated employer information reporting, the IRS will treat the employee or service provider as having received tips in the course of a trade or business that is NOT a SSTB if the employee is in an occupation that customarily and regularly received tips consistent with the proposed regulations issued. Beginning in 2026, more exact and standardized information reporting will be required of employers and other payors, allowing worker taxpayers to simply refer to their W-2 or 1099 forms.
• Interaction with employer tip credit. The OBBBA expanded the employer credit for social security taxes paid on employee tip income (Tip Credit) to include certain roles in the beauty industry. This may offer incremental incentive for salons or cosmetology employers to refine employee tip reporting policies. The Tip Credit was previously exclusive to the food and beverage industry,

Potential Challenges and Legal Implications for Employers

The OBBBA’s tax breaks for tips and overtime introduce several 2026 compliance and legal challenges for employers:

1. Enhanced Reporting and Documentation:
Employers must accurately track and report both overtime and tip income, including the occupation of each recipient. This may require significant updates to payroll systems and processes, especially for businesses with high employee turnover or multiple job roles.

2. Occupation Classification:
Only tips received in Treasury-approved occupations are eligible for the qualified tip deduction. Misclassification of employee roles could result in disallowed deductions and penalties. Employers and payors must ensure that job titles and duties align with the published Treasury regulations.

3. Coordination with Payroll Providers:
Businesses and those who use Outsourcing Accounting Services must ensure payroll providers and software vendors update systems to capture and report required data. While 2025 allows reasonable methods, stricter rules in 2026 will make proactive steps essential.

4. Anti-Abuse and Audit Risk:
The IRS has broad authority to issue regulations to prevent abuse, including reclassification of wages as tips or overtime. Employers should maintain thorough records and be prepared for increased scrutiny of payroll practices.

5. Industry-Specific Impacts:
Industries with complex compensation structures such as restaurants, hospitality, gaming, and transportation, face heightened compliance burdens. These sectors must pay particular attention to income from tip reporting and accuracy of overtime payroll reporting. Businesses with involuntary customer gratuity or service charge policies, may wish to re-evaluate how those arrangement impact their employees and non-employee service providers.

6. Legal Uncertainty and Future Guidance:
As the IRS and Treasury continue to issue guidance, employers must stay informed of the evolving requirements. Legal challenges may arise over the interpretation of “customarily and regularly tipped” occupations or the application of the SSTB exclusion.

FAQs

Does the OBBBA  eliminate federal tax on overtime pay?

No, the OBBBA does not eliminate federal tax on overtime pay. Instead, it allows individuals to deduct up to $12,500 ($25,000 for joint filers) of qualified overtime compensation from their taxable income for 2025–2028, subject to income phase-outs and specific reporting requirements.

Which industries are most impacted by the no-tax-on-overtime proposal?

Industries with large hourly or shift-based workforces, such as restaurants, hospitality, retail, healthcare, manufacturing, and transportation, are most affected. These sectors frequently pay overtime, and tips, making them primary beneficiaries of the new tax breaks and subject to new employer payroll compliance obligations.

How would these tax breaks affect employee paychecks?

While the tax breaks do not change gross pay, they allow eligible employees to deduct qualified tips and overtime from their taxable income, reducing their federal income tax liability and increasing take-home pay. The effect is most significant for lower- and middle-income workers who regularly earn tips or overtime.

How will these deductions affect state income tax liabilities?

The new federal deductions for qualified tips and qualified overtime compensation may reduce worker’s federal taxable income, but not all states automatically conform to these changes. As a result, workers could still owe state income tax on amounts deducted federally, so state taxable income may be higher than federal taxable income in those circumstances. Specific state’s rules determining the exact impact on state tax liability should be carefully addressed by individual taxpayers claiming the federal deductions.

Conclusion:
The OBBBA’s tax breaks for tips and overtime pay represent a major shift in federal tax policy for 2025–2028, offering substantial relief to millions of workers. However, the law also imposes new employer and payee statement reporting requirements, making careful planning and compliance essential for businesses in affected industries. As the IRS continues to issue guidance, employers and non-employee payors should stay proactive in updating their payroll and tip income reporting systems to ensure full compliance and maximize the benefits of these historic tax changes.

Tim Watt
Bennett Thrasher LLP
Phone: (770) 396-2200

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