Employer Compliance Update: Qualified Overtime and Tip Reporting After the One, Big, Beautiful Bill Act
•January 30, 2026
0
Why It Matters
The changes affect payroll compliance and tax planning, creating immediate operational costs for businesses while offering employees new deduction opportunities. Missing the 2026 deadline will trigger penalties, making timely system upgrades critical.
Key Takeaways
- •OBBBA requires separate W‑2 reporting for qualified overtime.
- •Qualified overtime deduction limited to $12,500 per employee.
- •Tips deduction capped at $25,000; mandatory service charges excluded.
- •Penalty relief ends 2026; systems must be updated now.
- •Employers may not give tax advice; refer employees to professionals.
Pulse Analysis
The One, Big, Beautiful Bill Act of 2025 marks a significant shift in how employers handle wage reporting, targeting both overtime and tip income. By mandating separate entries on Form W‑2, the legislation creates a clear data trail that the IRS can use to verify eligibility for new federal deductions. This move aligns payroll practices with broader tax policy goals, encouraging transparency while giving workers a modest avenue to offset higher earnings from overtime and tip‑based roles.
Qualified overtime under the OBBBA is narrowly defined: only the premium half‑rate paid for hours beyond 40 in a workweek qualifies, with a maximum deduction of $12,500 for single filers and $25,000 for married couples filing jointly. State‑specific daily overtime, such as California’s eight‑hour rule, does not meet the federal criteria, prompting employers to differentiate pay codes for daily versus weekly overtime. Similarly, tipped employees can deduct up to $25,000 of qualified tips, provided the amounts are voluntarily given by customers and not mandatory service charges. Tip‑pooling arrangements remain eligible, reinforcing the importance of accurate tip tracking.
Compliance hinges on timely system upgrades. The IRS offered a grace period for 2025, but that relief ends in 2026, after which penalties will apply for improper reporting. Companies should audit their timekeeping and payroll software to ensure distinct capture of FLSA overtime and qualified tip data, and they must train HR staff to avoid offering tax advice. Directing employees to qualified tax professionals mitigates liability and reinforces the separation between payroll administration and personal tax planning.
Employer Compliance Update: Qualified Overtime and Tip Reporting After the One, Big, Beautiful Bill Act
The One, Big, Beautiful Bill Act of 2025 (OBBBA) was signed into law on July 4, 2025. While its reach is broad, this article covers new employer tax reporting obligations. Under the OBBBA, employers must separately report qualified overtime compensation on employees’ Form W-2 and must report qualified tips and occupation codes for employees that customarily and regularly receive tips as of December 31, 2024. This information may be used by employees to claim a new federal income tax deduction on their individual returns.
Overtime. Under the Federal Labor Standards Act (FLSA), employees generally must receive overtime pay for hours worked in excess of 40 in a workweek at a rate not less than one and one-half times their regular rate of pay. Under the OBBBA, employees may take a limited deduction for overtime pay earned for hours worked beyond 40 in a workweek. Only the portion paid in excess of the employee’s regular rate qualifies – meaning the “half” portion of the “one and one-half times” paid for an hour of overtime work – is qualified overtime compensation. The OBBBA sets the annual deduction limit at $12,500 ($25,000 for married employees filing jointly).
Notably, state-law daily overtime (such as California’s requirement to pay overtime for hours worked over 8 in a workday) or contractual pay generally does not qualify for the deduction. As such, employers in California should separately report overtime paid on hours over 40 in a workweek. Employers may consider implementing one pay code for daily overtime and one for weekly overtime to simplify this reporting obligation.
Tips. The OBBBA also permits tipped workers to deduct up to $25,000 of qualified tips. It is important to note that to qualify as a tip, the customer must leave the amount voluntarily and what is given is not subject to negotiation. Mandatory service charges – such as a charge of 20% on all orders or on parties of a certain size – do not qualify, but tips received through tip-pooling arrangements does qualify.
Reporting Obligations and the End of Penalty Relief. The IRS provided penalty relief for employers who did not report qualified overtime compensation and tips separately for 2025. This transition period ends in 2026 and as such, employers must ensure that their timekeeping and payroll systems are updated to separately and accurately track FLSA-required overtime compensation and qualified tips and occupation codes for tipped employees.
Caution Against Providing Tax Advice: Employers should not provide their employees with tax advice or answer questions on how employees might use the newly reported information on overtime and tips to seek deductions on their individual returns and should instead advise employees to consult with a tax professional of their choosing.
For those with questions regarding these reporting obligations, feel free to reach out to the author or to your preferred Weintraub Tobin attorney.
0
Comments
Want to join the conversation?
Loading comments...