Federal law now provides tax deductions for overtime and tip income starting with the 2025 tax year. While employees can begin claiming these deductions when they file their 2025 returns in 2026, employers have new payroll reporting responsibilities to prepare for. For HR directors, payroll managers, and business owners in restaurants, hospitality, retail, and other industries with tipped and overtime workers, understanding these changes now ensures compliance and helps your employees maximize their tax benefits.
Are you an employee wondering how to navigate these changes?
The One Big Beautiful Bill Act (OBBB or H.R. 1) brings significant changes to how qualifying overtime and tip earnings are taxed and reported beginning with tax year 2025. In addition to the new federal deduction for overtime pay, the law also introduces a deduction for cash tips received by eligible employees. Both deductions are designed to lower federal taxable income for workers in industries where overtime and tipping are common, such as hospitality, restaurants, and retail.
- Employees can deduct up to $12,500 in premium overtime pay from their taxable income annually (or $25,000 for joint filers).
- For tips, the maximum deduction is $25,000 per return. The deduction applies only to amounts that meet the “qualified tip” criteria—generally, those tips that are reported to the employer and meet federal standards.
These new deductions can offer significant tax savings for employees who regularly earn overtime and tips, helping to offset their taxable income and increase their annual refunds. It’s important to note that only tips and overtime required and reported under federal law, not state-specific requirements or unreported tips, qualify.
Income Limits and Phase-Outs:
The benefit begins to phase out for individuals earning above $150,000 and for joint filers above $300,000 in annual income. Employees can claim the deduction when they file their personal income tax returns (Form 1040), which may reduce their federal tax liability or boost their refund. Keep in mind, overtime and tips remain subject to regular withholding for federal, state, Social Security, and Medicare—this new rule adds a deduction, not an exemption.
Employer Reporting Requirements: Current and Future
Accurate payroll tracking and reporting will be more important than ever under the new rules. Here’s what’s changing and what you’ll need to do:
- For Tax Year 2025 (W-2s issued in January 2026):
The IRS will not update Form W-2, Form 941, or related federal tax forms for the new overtime and tip deduction. Employers should continue reporting overtime and tip amounts as they have in previous years. The IRS is providing transition relief—there will be no penalties for not including separate detail for overtime or tips, provided employers comply with current FLSA federal requirements.
- For Tax Year 2026 Onward (W-2s issued in January 2027 and beyond):
New IRS reporting requirements take effect. Employers will need to implement the following changes to their filings:- Form W-2 Reporting:
- Box 12, use:
- Code TT to report qualified overtime compensation
- Code TP to report qualified tip income
- Box 14b will be used to report the Treasury Tipped Occupation Code, identifying employees in tipped occupations who may be eligible for the tip deduction.
- Box 12, use:
- Draft Form W-4 Updates:
Employees will have new options to claim estimated deductions for qualifying overtime and tips directly through payroll, potentially lowering their withholding throughout the year, rather than waiting until tax filing.
- Form W-2 Reporting:
Action Steps for Employers:
- Continue with current payroll reporting practices for 2025 and ensure compliance with FLSA overtime rules.
- Communicate with employees about new overtime and tip deduction opportunities, especially how these may affect annual tax filings or paycheck withholding in the future.
- Plan to update payroll and HR systems before 2026 to support new W-2 reporting requirements, including the use of Box 12 codes (TT and TP) and the occupation code in Box 14b.
- Monitor IRS and Treasury guidance for additional technical instructions and any payroll provider updates.
- Consider connecting with your payroll provider or technology vendor to confirm readiness for these changes.
Questions or concerns?
REDW’s trusted tax team has deep experience helping employers navigate complex federal reporting changes. If you have questions about how these new overtime and tip deductions affect your business—or need help preparing your systems for 2026 reporting requirements—contact Jeanna Schenk or Lori Woodbury for guidance tailored to your organization.
