Understanding the OBBBA Payroll Changes:

New Tip and Overtime Income Deductions

The passage of the One Big Beautiful Bill Act on July 4^th, 2025, has introduced changes to how tip and overtime income are treated for federal tax purposes.

Tip Income Deduction

For years beginning 2025 through 2028, a new temporary federal income tax deduction of up to $25,000 of annual qualified tip income has been enacted. This deduction allows taxpayers in an occupation designated by the IRS to offset qualified tips where tips are customary. The deduction begins to phase out when modified adjusted gross income (MAGI) is more than $150,000 ($300,000 for married joint filers).

The US Treasury Department recently released a list of these qualified occupations, a few of which include:

There are also certain trades or businesses that are specifically noted as NOT eligible for the tip deduction. Some of these include health, law, accounting, financial services, and investment management.

Qualified tips can be received from customers via cash, electronic payment, credit cards, or provided to workers through tip-sharing arrangements.

Overtime Income Deduction

Another temporary federal income tax deduction for tax years beginning 2025 through 2028 is the Overtime Income Deduction. This new deduction allows for an offset of up to $12,500 ($25,000 for married joint filers) of annual qualified overtime income. This deduction begins to phase out when MAGI is more than $150,000 ($300,000 for married joint filers).

Qualified overtime is the compensation paid to a worker as mandated under Section 7 of the Fair Labor Standards Act (FLSA). For a worker earning time-and-a-half overtime pay, only the portion over their regular wage (overtime premium) is considered qualified. As an example, a worker earning $20.00 per hour with a regular 40-hour work week, that works 50 hours that week would only be able to include the 10 hours of overtime at the $10.00 overtime premium rate as qualified overtime for the deduction. In this example, the deductible portion of their week wages would be $100.

Qualified overtime does not include overtime premiums that are not required by Section 7 of the FLSA, such as overtime premiums required under state laws or pursuant to contracts such as union-negotiated collective bargaining agreements. Qualified overtime income also cannot include any tip income.

The limited tip deduction and income deduction can be claimed whether the taxpayer is itemizing deductions on their tax returns or not.

Payroll Tax Impact

While these provisions of OBBBA have been referred to as “no tax on tips”, and “no tax on overtime”, they are actually limited, temporary federal income tax deductions as opposed to income tax exclusions. This means that income tax may still apply to some of your wages, and federal payroll taxes still apply to qualified tip and overtime income. Federal withholding tax rules still apply, and qualified tip and overtime income may still be fully taxable for state and local income tax purposes.

It will be critical for employers and payroll processing firms to correctly report qualified tips and qualified overtime income amounts to allow eligible workers to claim their rightful federal income tax deductions. It is recommended that employers begin tracking these items immediately and begin setting up systems to retroactively record qualified tips and overtime from the period of January 1, 2025 through OBBBA’s enactment on July 4^th.

The IRS has announced there will be no OBBBA-related changes to federal information returns for individuals, federal payroll tax returns, or federal income tax withholding tables for tax year 2025. According to the IRS, “these decisions are intended to avoid disruptions during the tax filing season and to give the IRS, business and tax professionals enough time to implement the changes effectively”. We will likely see updates to the 1099 forms, W-2, 941 and other payroll forms to allow for the reporting of qualified tip and overtime income in future years. The IRS is expected to provide transition relief for tax year 2025 and update forms for tax year 2026.

Please contact your Wegner Tax Advisor with any questions and let us help you navigate OBBBA’s impact.