The One Big Beautiful Bill Act (“OBBBA”), Section 70202(a), amends the Internal Revenue Code of 1986 (the “Code”) by adding new provisions providing for “no tax on overtime and tips” for eligible workers. This new law is intended to reduce taxable income for hourly and tipped workers by allowing up to a $12,500 ($25,000 for married filing jointly) deduction for qualified overtime compensation and up to a $25,000 deduction for qualified tip income.

Employers should begin preparing now to ensure proper recordkeeping, payroll compliance, and employee communication about these changes. Specifically, personnel handling payroll must understand how to identify “qualified overtime compensation” and “qualified tip income,” while managers should be prepared to explain the favorable tax treatment to employees.

Overtime Tax Deduction

Under new Code Section 225(c), “qualified overtime compensation” is defined as overtime pay meeting all three of the following criteria:

1. FLSA Requirement: The overtime pay must be required under the Fair Labor Standards Act (29 U.S.C. § 207).
2. Premium Portion Only: Only the amount required to be paid under the FLSA that exceeds the employee’s regular rate of pay qualifies.
3. Proper Reporting: The overtime pay must be reported on a Form W‑2, Form 1099, or another statement specified by the IRS.

The definition excludes overtime pay that does not meet FLSA requirements, such as state-mandated daily overtime (e.g., California’s daily threshold), contractual overtime under a collective bargaining agreement, and voluntary or incentive-based overtime that is not required by the FLSA.

For 2025, the IRS has provided transitional relief and the IRS will not penalize employers who do not separately report qualified overtime compensation. As for 2026, the 2026 tax forms are not yet released, but employers should expect guidance, updated forms and instructions later this year. Employers should check with their payroll providers to see how they can track and record qualified overtime compensation from other overtime pay.

New Tip Income Deduction

In addition to overtime relief, the OBBBA creates a similar exclusion for “qualified tip income.” Under Section 224(d) of the Code, employees may deduct certain tip income from federal taxation if it satisfies all the following conditions:

1. Direct Receipt: The tips must be received by the employee directly from customers or through a valid tip pool.
2. Reportable Income: The tips must be properly reported to the employer and reflected on a Form W‑2, 1099 or 4137.
3. FLSA Coverage: The employee must be engaged in an occupation that customarily and regularly receives tips.

This new deduction allows eligible tipped employees to reduce taxable income, aligning tip reporting more closely with federal overtime incentives.

Employers should review tip reporting processes, re‑train managers on the definition of reportable tips, and ensure payroll systems are updated to reflect this new category of qualified income.

Income-Based Deduction Limits

Employees’ eligibility to claim the full deduction for qualified overtime and tips depends on filing status and modified adjusted gross income (“MAGI”) as shown below:

Filing Status	Maximum Deduction	Phase-Out Begins	Full Phase-Out Complete
Single/Head of Household	$12,500	$150,000 MAGI	$275,000 MAGI
Married Filing Jointly	$25,000	$300,000 MAGI	$550,000 MAGI
Married Filing Separately	Not eligible	N/A	N/A

Employers may wish to distribute this chart or direct employees to upcoming IRS guidance titled “Qualified Tips and Overtime for Individual Taxpayers.”

Employer Action Steps

• Review payroll systems to confirm compliance with new reporting requirements.
• Train HR and payroll teams to identify and document qualified overtime and tip income.
• Communicate benefits to affected employees to ensure accurate reporting and timely tax filings.
• Stay alert for forthcoming IRS and Treasury Department regulations providing procedural guidance for applying these deductions.

For detailed compliance advice or to update your policies and employee communications, contact Terese Connolly, Ivan Golden, or your Taft attorney.