The “One Big Beautiful Bill Act” (“OBBBA”) signed on July 4, 2025, enacts the widely publicized “No Tax on Tips” and “No Tax on Overtime” changes to the tax code. These provisions will decrease tax burdens for many employees, but also present new compliance obligations for employers. These changes are retroactive to January 1, 2025, so employers should be focused on these issues now.

The IRS has released FS-2025-03 with interim guidance on the changes, but more detailed guidance is expected in the coming months.

Here are the key things that employers should know:

No Tax on Tips

The OBBBA allows a deduction of up to $25,000 for “qualified tips,” regardless of filing status. To be considered a “qualified tip” subject to the deduction, the tip must be a voluntary tip received by an individual in an occupation that customarily and regularly received tips prior to the enactment of the OBBBA. This means employers cannot craft novel pay arrangements for traditionally non-tipped positions in response to the law. The U.S. Treasury is expected to release a list of the relevant qualified tipped occupations by October 2, 2025. Further, the tip must be paid voluntarily without any consequence in the case of nonpayment, which means that mandatory service charges or auto-gratuities are not considered “qualified tips” for purposes of the deduction.

No Tax on Overtime

Separately, the OBBBA allows a deduction of up to $12,500 per employee ($25,000 if married) for certain overtime payments received by the employee.

Importantly, the deduction is limited to “qualified overtime compensation” required to be paid under the Fair Labor Standards Act (“FLSA”), meaning overtime for hours worked in a week over 40 hours. Other forms of premium pay are not subject to the deduction–such as where state law overtime requirements exceed those of the FLSA or a company policy or collective bargaining agreement provides for premium pay for certain shifts or certain types of work. For example, if an employer’s policy provides for time and a half pay for work performed on a holiday or Saturday, that premium pay would not be considered “qualified overtime compensation” for the purposes of the tax deduction unless the pay also qualifies as overtime required to be paid under the FLSA.

An additional administrative complication for employers is that only the compensation in excess of the regular rate can be included in the deduction. For example, if an employee’s regular rate of pay is $10 an hour and they receive $15 an hour for overtime hours, only the $5 per hour overtime premium would qualify for the deduction.

Both the “No Tax on Tips” and “No Tax on Overtime” deductions begin to phase out for taxpayers earning over $150,000 (or $300,000 if married).

New Employer Responsibilities

Because these changes are retroactive to January 1, 2025, employers should be prepared to implement them for the full 2025 tax year. The IRS has stated that Forms W-2 and 1099-NEC will not change to reflect new reporting requirements until 2026, and additional information will be provided in the coming months explaining how taxpayers can claim the OBBBA related benefits for 2025 under existing forms and withholding guidelines.

Where recordkeeping before July 2025 is an issue, there is a transitional rule within the OBBBA that allows for estimation of cash tips and qualified overtime by IRS approved methods.

These new tracking and reporting requirements could prove more challenging to implement than might initially be expected, particularly with respect to qualified overtime compensation. Many employer payroll systems currently report overtime compensation on a separate line item in an employee’s pay stub that includes both the regular rate, and the premium rate paid for the overtime hours. However, as discussed above, only the premium rate (i.e., the 0.5 of the 1.5 overtime paid) qualifies for the deduction and will need to be separately reported to claim the deduction. Employers would be well-served to analyze the current tracking and reporting functionalities of their payroll systems now to ensure they are best positioned to comply with reporting requirements as new IRS guidance emerges in the coming months. 

In sum, though these new tax deductions offer meaningful tax relief for certain types of workers, employers’ key role in successful implementation comes with new compliance obligations and reporting burdens. Early preparation and clear communication with employees and payroll providers will be critical.