The One Big Beautiful Bill Act (“OBBBA”), enacted in July 2025, temporarily eliminates taxes on qualified overtime and qualified tips through 2028. This new law is intended to reduce taxable income for hourly and tipped employees by allowing up to a $12,500 (single) or $25,000 (married filing jointly) deduction for qualified overtime compensation and up to a $25,000 deduction for qualified tip income. This is particularly relevant to employers whose workforces rely heavily on gratuities and overtime.

Employers will be required to track overtime and tipped wages and report a separate accounting of each to employees. Employers should ensure proper recordkeeping and employee communication about these changes. Payroll personnel must understand how to identify “qualified overtime compensation” and “qualified tip income,” while management should be prepared to explain the favorable tax treatment to employees.

Temporary Deduction for Qualified Tips

Eligible employees may deduct up to $25,000 annually in reported “qualified tips,” subject to income phase-outs beginning at approximately $150,000 for single filers or $300,000 for joint filers. This deduction applies only to workers in occupations that regularly receive tips.

“Qualified tips” are defined as voluntary cash or charged tips received from customers or through tip pools. Mandatory service charges and automatic gratuities added to a bill are excluded.

Temporary Deduction for Qualified Overtime

Employees may deduct up to $12,500 annually for single filers or up to $25,000 for joint filers for “qualified overtime” compensation, subject to income phase-outs beginning at approximately $150,000 for single filers or $300,000 for joint filers. Only the portion that exceeds the employee’s regular rate of pay may be deducted.

“Qualified overtime” is defined as overtime pay earned for hours worked beyond 40 in a workweek. State-law daily overtime (e.g. California’s daily overtime) or contractual overtime under a collective bargaining agreement generally do not qualify for the deduction.

Employer Obligations

Beginning in the 2026 tax year, employers will be required to separately report qualified overtime compensation and qualified tips on W-2s or Form 1099s. While current W-2s and Form 1099s do not provide space for reporting qualified overtime and tips, the IRS has issued guidance for Employers, while updated forms and instructions are expected to be published later this year: [https://www.irs.gov/pub/irs-drop/n-25-69.pdf].

The IRS will not punish Employers for failing to comply with the OBBBA’s reporting requirements for the 2025 tax year, but non-compliance in the 2026 tax year and thereafter could result in penalties once the transition relief period expires.

Employers should check with their payroll providers to accurately track and record qualified overtime compensation from other overtime pay. If you outsource HR or payroll to a third party, discuss with your provider how they are preparing and how processes will change to ensure accurate recordkeeping and documentation.

Employees with questions about the temporary deductions and how to file their individual tax returns should consult a tax professional or the IRS for guidance.

Stokes Wagner will continue to monitor updates and will provide additional updates as they become available. If you have any questions, do not hesitate to contact a Stokes Wagner attorney.

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THIS DOCUMENT PROVIDES A GENERAL SUMMARY AND IS FOR INFORMATIONAL/EDUCATIONAL PURPOSES ONLY. IT IS NOT INTENDED TO BE COMPREHENSIVE, NOR DOES IT CONSTITUTE LEGAL ADVICE. PLEASE CONSULT WITH COUNSEL BEFORE TAKING OR REFRAINING FROM TAKING ANY ACTION.