With the passage of the new federal tax bill on July 4, 2025, unofficially referred to as the One Big Beautiful Bill Act (OBBBA), employers and employees in overtime-heavy and tipped industries face new opportunities and responsibilities. Below are some key highlights of what employers need to know to better prepare for the changes.
Overtime Income Tax Deduction FAQs: Who Benefits and How It Works
Is overtime compensation now “tax free”?
No. Overtime compensation is still considered taxable income and will be subject to federal and state income taxes and FICA withholding. Thus, there should be no changes to the employer’s payroll administration and reporting. However, employees can deduct up to $12,500 in “qualified overtime compensation” per year. For joint filers, the deduction is $25,000. This deduction is available in full for workers with adjusted gross income (AGI) under $150,000 or $300,000 for joint returns. The deduction phases out by $100 for every $1,000 over the threshold.
This deduction is a temporary provision effective for 2025 and set to expire at the end of 2028 unless extended by future legislation.
What counts as qualified overtime compensation that can be deducted?
Only the premium portion of overtime pay required by the federal Fair Labor Standards Act (FLSA) qualifies for the tax deduction (i.e., the “half” of “time and one-half” for hours worked over 40 in a week). For example, if an employee earns $10 per hour and works overtime at $15 per hour, only the $5 per hour premium for overtime is deductible, subject to the AGI limits. Overtime premiums paid solely due to state law, union contracts, or company policy, such as daily overtime in California, do not qualify. Only FLSA-mandated premiums are eligible.
Should we stop withholding taxes on employee overtime compensation?
No. Employers should continue withholding taxes from employee overtime compensation just as they always have.
Should employees still report overtime compensation as income?
Yes. Employees are still required to report overtime compensation as taxable income and will need to work with their own tax advisors to determine whether they qualify for the overtime deduction.
Tip Income Tax Deduction FAQs: Who Qualifies and What Counts
Are tips now “tax free”?
No. Tips are still considered taxable income and will be subject to federal and state income taxes and FICA withholding. However, for tax years 2025 through 2028, employees in “traditionally tipped occupations” can deduct up to $25,000 of “qualified tips” from their federal taxable income each year. For joint filers, the deduction is $50,000. Similar to overtime wages, this deduction is available in full for workers with adjusted gross income (AGI) under $150,000 or $300,000 for joint returns. The deduction phases out by $100 for every $1,000 over the threshold.
Who qualifies for the deduction?
The OBBBA requires the Treasury Secretary to publish an official list of “traditionally tipped occupations” by October 2, 2025. Only roles that were customarily and regularly tipped as of the end of 2024 will qualify. Employers cannot reclassify non-tipped positions to take advantage of the deduction.
What counts as a qualified tip?
- Tips must be voluntary, customer-determined, and non-negotiated.
- Service charges or automatic gratuities do not qualify.
- Tips received through tip-sharing arrangements are eligible, as long as they are voluntary and reported.
- All tips must be properly reported for the deduction to apply.
Should we stop withholding taxes on employee tips?
No. Employers should continue withholding taxes from tips just as they always have.
Should employees still report tips as income?
Yes. Employees are still required to report tips as taxable income.
Reporting Qualified Tips and Overtime
Since the law provides tax benefits through deductions, do employers have any obligations?
Yes. Employers should bear in mind the following:
- Employers must separately track and report “FLSA overtime premiums and qualified” tips on Form W-2.
- For 2025, the OBBBA allows employers to use a “reasonable method” approved by the Treasury Secretary to estimate qualified overtime and tips. As of now, exact reporting will be required starting in 2026.
- FICA and income tax withholding rules for overtime and tips remain unchanged. These amounts are still subject to standard payroll taxes.
Because the OBBBA is such new legislation, its full impact and the practical implications for employers and employees will become clearer as regulations and other guidance are developed and released. Employers should stay informed and be prepared to adapt as more details emerge.
If you have questions about how these changes may affect your business or need assistance with compliance, please reach out to any Husch Blackwell professional for guidance.
Employers should advise employees to seek help from a qualified tax professional if they have any questions about their tax obligations under OBBBA.
Summer associate Sebastian Matchneer contributed to this update.