Seyfarth Synopsis: The freshly enacted "One Big Beautiful Bill" introduces two above-the-line tax deductions for tips and overtime wages. While these deductions offer potential savings for eligible workers, they come with new compliance obligations and nuanced legal considerations that employers will need to navigate carefully.
With Sharpie in hand and military jets overhead, President Trump marked Independence Day by signing H.R. 1, best known as the "One Big Beautiful Bill," or "OBBB"—into law. Among the bill's myriad provisions are two long-promised pledges: no tax on tips, and no tax on overtime.
Starting with the 2025 tax year, OBBB will allow workers below certain income thresholds to deduct up to $12,500 in "qualified overtime compensation" ($25,000 for on a joint return), and $25,000 in "qualified tips." To emphasize the benefit for impacted workers, the White House has launched a calculator on its OBBB website, which calculates estimated tax savings based on user inputs for weekly base wages, tips, and overtime.
Of course, these provisions' full impact lies in the details. The OBBB reflects nuance about which workers are eligible for deductions, and what amounts they may deduct. For employers, the new law may require updated wage tracking and reporting capabilities, and it could cause a shift in an already shaky wage-hour litigation landscape.
No Tax on Qualified Tips
For 2025 tax returns, the OBBB will allow an above-the-line deduction of up to $25,000 in "qualified tips" for workers in "traditionally tipped occupations." The deduction is available in full for workers with adjusted gross income ("AGI") under $150,000 ($300,000 for a joint return), and phases out by $100 for every $1,000 over the AGI threshold.
So who qualifies as "traditionally tipped"? Per the OBBB, the Treasury Secretary has until October 2, 2025 (90 days post-enactment) to publish an official list. The statute clarifies that roles not "customarily and regularly tipped" as of the end of 2024 are excluded. In other words, this isn't an opening to recast untipped roles as tipped to seize a deduction.
As for "qualified tips," they must be voluntary, customer-determined, and non-negotiated. And of course the tips must be reported. Tips earned through a tip-sharing arrangement count, but service charges and other mandatory fees do not.
FICA and income tax withholding still apply. Employers must continue reporting tips as before.
Moreover, employers will now be required to track and report "qualified" tips for W-2 reporting. For the 2025 tax year, employers may rely on a "reasonable method" approved by the Treasury Secretary for estimating qualified tips, but exact reporting will be required starting in 2026.
No Tax on Qualified Overtime
The OBBB allows a deduction of up to $12,500 in "qualified overtime compensation" ($25,000 for a joint return), with the same AGI thresholds and phase-out as the tipped wage deduction.
Critically, this only applies to overtime pay required by the FLSA, and only the premium portion above the "regular rate." For an oversimplified example, an employee who earns nothing more than a base rate of $10/hour and $15/hour for each overtime hour could only deduct the $5/hour overtime premium (subject to the income limits noted above).
As written, it appears that overtime premiums paid pursuant to state law (e.g., daily overtime in Alaska, California, Colorado, or Nevada), a collective bargaining agreement, or employer policy would not qualify for deduction. The deduction is reserved for overtime premiums as defined by the FLSA.
As with tips, employers will need to record and report qualified overtime compensation on the Form W-2. To do this, they must be able to isolate overtime premiums required by the FLSA. For 2025, similar to reporting for tips, the OBBB permits reporting "approximate" qualified overtime compensation pursuant to a "reasonable method" specified by the Treasury Secretary.
What it Means for Employers
While these tax benefits apply to employees, some administrative burden falls on employers. With these changes taking effect for the 2025 tax season, preparation should begin now. Employers should consider the following action items:
- Review payroll and reporting systems. Employers will need to consider whether system changes are needed to comply with new Form W-2 reporting rules and support employees in calculating their deductions. Systems will need to be able to distinguish qualified tips as well as qualified overtime compensation.
- Assess exempt job classifications. It'll be more important than ever to ensure confidence when classifying a job as exempt from overtime. Employees classified as exempt may may be more likely to challenge that status when the financial benefits of overtime compensation increase through this deduction.
- Educate employees. In some scenarios, employers may need to manage their employees' expectations. For example, it may warrant emphasizing that these changes present tax deductions, not raises, and workers won't see the benefit until they file their 2025 tax returns in 2026.
- Assess tipping protocols and practices. Mandatory charges like automatic service charges don't qualify for deduction, nor do unreported tips. Employers may need to reinforce tip-reporting protocols and educate employees on tipped wage practices. Given the publicity around these changes, employers may also need to consider how they will field customer questions about tipping practices, service charges, and the like.
- Monitor regulatory guidance. We will see Treasury guidance on, at a minimum, qualifying tipped occupations and acceptable reporting methods. This is important to watch.
The Bigger Picture
Beyond tax season, the OBBB may have broader impacts for employers.
These changes may make tipped roles more attractive. The same is true for overtime shifts. In some industries, this could impact talent recruiting and retention. Employers may also need to evaluate staffing and compensation models as they are pushed to emphasize tipped and overtime wages.
Increasing the value of tips and overtime earnings could also impact employment litigation. At least in theory, employees should be more cognizant than ever of the tipped and overtime wages they bring home. They may, as a result, be more likely to pursue litigation concerning the same. And in settlements of employment litigation, plaintiffs' attorneys may focus more intently on how back wages are allocated, impacting how agreements are structured and payments reported.
While these deductions are hardly the only newsworthy items to extract from the OBBB, they are important and will require careful consideration and planning.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
