The One Big Beautiful Bill Act (OBBBA), signed into law on July 4, 2025, introduces new federal income tax deductions for eligible employee overtime pay and tips. To comply, employers should act now on payroll, reporting, and withholding updates.

Overtime Pay Deduction
The OBBBA provides a temporary deduction for the premium portion of an employee’s overtime pay.

• Eligibility: The deduction is only for the “premium pay” on overtime hours worked over 40 hours in a week, as defined by the Fair Labor Standards Act (FLSA). If a state or union contract provides a higher overtime rate, only the FLSA-mandated premium portion is eligible for the deduction. For example, if an employee’s regular rate is $10/hour and their overtime rate is $15/hour (time-and-a-half), the deductible amount is the $5/hour premium.
• Deduction Limits and Phase-Outs: The deduction is capped at $12,500 for single filers and $25,000 for joint filers. This amount is reduced by $100 for every $1,000 that the employee’s gross income exceeds $150,000 ($300,000 for joint returns).

Tips Deduction
The law also allows for a deduction for tips received by workers in “traditionally and customarily tipped industries.”

• Eligibility: The deduction is available for tips earned in industries that the Treasury Department is required to list by October 2, 2025. It applies to both employees and non-employees (e.g., independent contractors working through third-party settlement organizations).
• Deduction Limits and Phase-Outs: The maximum deduction is $25,000. Similar to the overtime deduction, this amount is reduced by $100 for every $1,000 that the employee’s gross income exceeds $150,000 ($300,000 for joint returns).

Key Employer Action Items for 2025
- Update payroll systems to track overtime premium pay and qualifying tips separately.
- Report deductible amounts on Form W-2 (new requirement).
- Update federal income tax withholding to reflect new deductions.
- Coordinate with payroll providers now to avoid year-end errors.

Taking Action Now
The OBBBA is already in effect, and employers can’t wait until year-end. Updating payroll systems now will ensure compliance, avoid errors, and help employees maximize these valuable new tax breaks.

While the Treasury Department has until October to finalize the list of qualifying tipped industries, employers in traditionally tipped sectors should begin preparing now. Our team can help you interpret the rules and work with your payroll provider to implement changes smoothly.