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As we wrote on July 14, 2025, the One Big Beautiful Bill Act (OBBA) contains a provision providing a tax deduction for employees' overtime income in 2025 through 2028.
Originally, the data regarding such overtime income was to be reported on a W-2 form. However, as employers are preparing their 2025 W-2 forms (to be issued in January 2026), the IRS has provided some relief. Employers now may — but are not required to — include the qualifying overtime in the employee's W-2 form. If an employer chooses not to include the deductible overtime on the W-2 form, the employer still has obligations and must provide the employee with detail on any overtime that is potentially deductible in some form. This detail can be in a memo to the employee explaining what overtime the employee earned that is eligible for the deduction. Starting next year, employers will have to report overtime on a W-2 form, as the IRS plans to update the form for employers to include such information.
Given these circumstances, employers need to understand what overtime payments are potentially deductible for employees. To that end, the only overtime that is eligible for a deduction is overtime that is required under the Fair Labor Standards Act. As a consequence, any overtime earned by an employee under any state law (that would not be required under federal law) is not eligible for the deduction and should not be reported as qualifying overtime either on the W-2 or in the 2025 report to an employee about such overtime.
An example of such non-reportable overtime would be California's required overtime payments for more than eight hours worked in a single workday. Likewise, any overtime paid by an employer for working fewer than forty (40) hours a week would not be eligible for the deduction and is therefore not reported to the employee as eligible for the federal deduction. Such overtime could be under a collective bargaining agreement or another pay plan under which an employer voluntarily pays overtime for fewer than forty hours.
Employers need to be thinking now about how they will be determining what is eligible overtime to be reported to the employee. Employers should also establish a means to easily track what overtime is eligible for the deduction to ensure that the information is readily available. And remember: all overtime compensation remains subject to Social Security and Medicare taxes.
Additionally, the OBBA also provides for a deduction for qualified tips. Qualified tips are generally those received by an individual in an occupation that regularly received tips on or before December 31, 2024. Similar to overtime payments, for 2025, employers will not be required to separately report tips on a W-2 or Form 1099. Employees are to rely on pay stubs, tip logs, and Form 4137 (for unreported tips). The IRS has indicated that it will accept reasonable methods for calculating qualified tips for 2025. As with overtime, the tips are still subject to Social Security and Medicare taxes.
There are limits to what amounts are deductible for employees regarding overtime and tips. Therefore, employers should be careful not to merely tell an employee that the amounts are deductible and instead should simply inform the employee that the amounts may be deductible, to avoid inadvertently providing the employee with tax advice.
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.
