Starting January 1, 2025, the One Big Beautiful Bill Act (OBBBA) introduces new federal income-tax deductions for “qualified tips” and “qualified overtime compensation.” For payroll administrators, this means changes in tracking, reporting, and communication to ensure employees can claim these deductions.
Qualified Tips
Definition:
- Cash tips (or equivalent) received voluntarily by employees in occupations “customarily and regularly tipped” as of December 31, 2024.
- Mandatory service charges or automatic gratuities do not count.
- Eligible occupations will be listed by the IRS using the “Tipped Occupation Code” system.
Reporting Requirements:
- Separate reporting of tips and employee occupation codes begins in 2026.
- Transition Rule for 2025: penalties are waived if tips are not separately reported.
- Voluntary reporting (e.g. Box 14 on W-2 or supplemental statement) is recommended to help employees claim the deduction.
Payroll Considerations:
- Track cash tips separately from other gratuities.
- Maintain employee occupation codes for future reporting.
- Consider issuing supplemental tip statements for 2025 as a best practice.
Qualified Overtime Compensation
Definition:
- Only the “premium” portion of overtime pay under FLSA rules (i.e. half-time beyond regular pay) qualifies.
- Other overtime (e.g. double-time, state-law, union contract outside FLSA) may not qualify. Check with your CPA for final determination of the overtime pay to be reported.
Reporting & Deduction Limits:
- Deduction limits: $12,500 per year (single) / $25,000 per year (married filing jointly).
- Available even for employees taking the standard deduction.
- Transition Rule for 2025: separate reporting not required (however, supplemental statements are encouraged).
Payroll Considerations:
- Payroll systems may need updates to isolate overtime premium pay.
- Ensure accurate calculations for employees with multiple rates, variable hours, or complex overtime rules.
- Communicate changes to payroll/HR teams and software vendors to prepare for 2026 reporting.
2025: A Transition Year
For tax year 2025, there will be no penalties for not separately reporting tips or overtime premium on W-2s/1099s. However, employers should use this period to prepare for future payroll and year end processing of the new overtime and tip requirements. These provisions include:
- Continuing to report all wages, tips, and overtime pay in Box 1 of Form W-2 as usual.
- Updating payroll systems to accommodate the new rules, accurately tracking tipped occupations, and preparing to generate supplemental statements.
- Communicating with employees about qualified tips and overtime compensation to help them maximize their deductions.
Action Checklist for Payroll Administrators
- Confirm payroll system capabilities for separate tip and overtime premium tracking.
- Identify employees in historically tipped occupations using IRS guidance.
- Adjust time-tracking and payroll workflows to isolate overtime premium pay.
- Prepare supplemental statements (or Box 14) showing qualified tips and overtime premium.
- Communicate with employees about deductions and reporting.
Final Thoughts
The Big Beautiful Bill’s provisions for tips and overtime represent a significant shift in payroll administration. For additional details and guidance please review the IRS website, which contains helpful recent news and FAQs. While 2025 is a transition year, proactive planning ensures compliance and supports employees in maximizing their deductions. By updating systems and communicating effectively, payroll teams can navigate these changes smoothly and provide meaningful support to their workforce.
If your organization uses a modern Human Capital Management (HCM) system, the software will certainly help ease this burden by automating many of these tasks. If you’re interested in how an HCM system can help you manage these types of events in the future, please get in touch. Talk to a Payroll Expert!
