Tips, Overtime & Compliance: What Employers Need to Know About the “No Tax on Tips” and “No Tax on Overtime” Deductions

The recently passed “One Big Beautiful Bill Act” introduces two significant new federal deductions for employees, aimed at tips and overtime pay. These provisions are set to impact payroll, reporting, and compliance beginning with the 2025 tax year. Here’s what HR and finance leaders should know now to prepare.

Legislative Background

Signed into law: July 4, 2025

Applies to: Tax years beginning after December 31, 2024

Sunset date: Deduction ends after the 2028 tax year unless extended

Two new sections of the Internal Revenue Code were created:

• Section 224: Qualified Tips Deduction

• Section 225: Qualified Overtime Deduction

The New Qualified Tips Deduction (IRC 224)

• Deduction Amount: Up to $25,000 per year for properly reported cash tips

• Eligibility:

  • Must work in a customary tipped occupation as of December 31, 2024

  • Tips must be voluntary, directly from customers, and properly reported

  • Deduction not available for specified service trades/businesses (law, accounting, finance, etc.)

• Income Phaseouts: Begins at $150,000 (single) / $300,000 (joint); reduced $100 for each $1,000 over

Reporting Tips: What Employers Must Do

• Reporting Requirements:

  • Employers must list both the tips and occupation on W-2s, 1099s, or Form 4137

  • Beginning in 2026, IRS withholding tables will adjust for this deduction

• Transition Rule: For 2025 only, employers may use a “reasonable method” to estimate cash tips

Key Takeaway: Employers should update payroll systems, ensure accurate reporting, and monitor Treasury’s upcoming list of qualifying occupations and anti-abuse rules.

The New Qualified Overtime Deduction (IRC 225)

• Deduction Amount: Up to $12,500 per individual / $25,000 joint

• Eligibility:

  • Applies only to non-exempt employees under the Fair Labor Standards Act (FLSA)

  • Covers the “half” portion of time-and-a-half pay for hours worked over 40 per week

• Income Phaseouts: Same thresholds as tips ($150,000 single / $300,000 joint)

Overtime Reporting & Compliance Checklist

• Reporting Requirements:

  • W-2s must show qualified overtime separately

  • 1099s must report overtime amounts for contractors, if reasonably designated

• Transition Rule: For 2025 reporting, a “reasonable method” may be used to estimate amounts

• Compliance Reminders:

  • Keep clear and accurate time/pay records

  • Properly classify exempt vs. non-exempt employees

  • Avoid abuse by disguising overtime as bonuses or inflated base pay

Key Takeaway: Accurate timekeeping and proper employee classification will be critical to compliance.

Action Steps for Employers – HR, Payroll & Finance Leaders

1. Review Payroll Systems – Confirm they can track and separately report qualified tips and overtime.

2. Train HR & Payroll Teams – Ensure staff understand the new reporting and compliance requirements.

3. Communicate with Employees – Educate staff in tipped or non-exempt roles about how the deductions apply to them.

4. Monitor Guidance – The Treasury Department will issue further rules on qualifying occupations and anti-abuse provisions.

5. Plan for Withholding Changes – Updates to IRS withholding tables take effect beginning in 2026.

Looking Ahead: Preparing for 2026 and Beyond

These new deductions create opportunities for employees but also increase employers’ reporting responsibilities. With proper preparation, HR and finance leaders can stay compliant while helping employees benefit from the new law.

We will continue to monitor IRS guidance and provide updates as more details are released.