Home - Blank Rome LLP

Register to receive insights and analyses on breaking news and trends across varying industries.
<a class="link-primary mt-4" href="/subscribe">Subscribe</a>

Philadelphia, PA

New York, NY

Wilmington, DE

Cincinnati, OH

Princeton, NJ

Los Angeles, CA

Houston, TX

Tampa, FL

Shanghai

South Florida

Pittsburgh, PA

Washington, D.C.

Chicago, IL

Orange County, CA

Dallas, TX

Boston, MA

The One Big Beautiful Bill (“OBBB”), signed by President Trump on July 4, 2025, allows workers (subject to dollar and income limitations) to deduct, on their U.S. federal income tax return, overtime payments and tips that they receive during calendar years 2025 through 2028. Here is a summary of what these changes mean to employers.1

core/paragraph

core/heading

To receive favorable tax treatment for U.S. federal income tax purposes, the tip must be paid to an individual “in an occupation which customarily and regularly received tips on or before December 31, 2024.” The Treasury Department is directed to publish, not later than October 2, 2025, a list of occupations which satisfy this condition. It remains to be seen whether this will be an exclusive list, or whether businesses will be permitted to identify other occupations that meet the standard. The following businesses are specifically excluded from eligibility: accounting, health, law, actuarial science, athletics, brokerage services, consulting, financial services, and the performing arts.

core/list-item

The tip deduction is limited to “cash tips,” which the OBBB defines as “tips received from customers that are paid in cash or charged.” Presumably, Internal Revenue Service (“IRS”) guidance will clarify that this definition extends to payments using digital payment platforms. The definition also includes tips received under a tip sharing arrangement.

core/list

Recordkeeping Challenges for Overtime Pay

The OBBB grants favorable tax treatment to “qualified overtime compensation,” which it defines as “overtime compensation paid to an individual required under section 7 of the Fair Labor Standards Act of 1938 that is in excess of the regular rate (as used in such section) at which such individual is employed.” This means that, for example, where a non-exempt employee’s hourly rate is $10.00 (and the corresponding overtime rate is $15.00 per hour) and the employee works one hour beyond 40 hours in a work week (so, a total of 41 hours), the available deduction is only for the $5.00 of overtime premium for that one overtime hour – and not for the $10.00 of regular straight time pay. Also, a higher overtime rate or more generous overtime eligibility under state law (such as an entitlement to overtime pay for working more than eight hours in a day under California law), or pursuant to a collective bargaining agreement, does not qualify for the deduction, nor do shift differential payments or payments in excess of the federal overtime rate paid for working on a holiday. This will place a burden on employers (more about this below) to identify amounts paid as federal overtime pay premiums under the Fair Labor Standards Act and also to distinguish and segregate those premiums from overtime pay required solely by state laws or contract.

Income Tax Withholding and Employment Taxes

Because the new law reduces an employee’s income tax by giving the employee an income tax deduction (which, helpfully, can be deducted by the employee without having to itemize deductions), overtime pay and tips remain includable in wages subject to income tax withholding. The IRS has been directed to modify the income tax withholding “procedures” to take into account the employees’ overtime pay and tip deductions. Employers, who bear the potential burden of penalties attributable to under-withholding, will need to be on the lookout for these procedures.

Because 401(k) plans commonly define compensation as income tax withholding wages, the new overtime and tips deductions will not impact the operation of most 401(k) plans.

Overtime and tip payments continue to be subject to Social Security and Medicare taxes.

There are new W-2 reporting requirements.&nbsp;

Employers will need to separately specify on an employee’s W-2 the amount of the employee’s qualifying overtime pay.

Employers with employees who receive tips will need to specify the amounts that have been “reasonably designated” as cash tips and the employee’s occupation that customarily and regularly received tips as of December 31, 2024.

Because the OBBB states that the overtime pay and tips deductions can be taken for amounts identified as such on an employee’s W-2, how the employer handles these new reporting requirements takes on particular significance for employees.

Under a transition rule for 2025, an employer “may approximate” on employees’ W-2s the amount of qualified overtime compensation and the amount designated as cash tips under “any reasonable method specified” by the IRS. This is another aspect of the law where employers will need to keep track of what the IRS has to say when the IRS provides guidance.

On July 14, 2025, the IRS published a fact sheet (FS-2025-03) on its website announcing that “it will provide transition relief for tax year 2025” for people claiming the tips and overtime deduction and for employers “and other payors” who have to comply with the new reporting requirements. In accordance with historical IRS transition relief approaches to changes in the law, this relief will presumably give workers, employers, and other payors leeway for 2025 in addressing the new law.

The OBBB’s income tax deduction for overtime compensation and tips will benefit a potentially large number of employees, but while doing so, it will impose material administrative burdens on employers.&nbsp;

core/separator

[1] Under the OBBB, self-employed workers are also eligible for the overtime and tip deductions (the overtime deduction being somewhat confusing, since workers who are independent contractors—unless mischaracterized—are not eligible for overtime).

What the New Tax Treatment of Overtime Pay and Tips Means to Employers

Offices

Stay Connected

Slide Menu

Slide Search

What the New Tax Treatment of Overtime Pay and Tips Means to Employers

Offices

Stay Connected