Client Alert: No Tax on Tips or Overtime in the “One Big Beautiful Bill Act” What Employers Need to Know Now
CLIENT ALERT
By Attorney Sandra F. O’Neill
The One Big Beautiful Bill Act (the “OBBA” or the “Act”) that President Trump signed into law on July 4th fulfilled one of the President’s campaign promises: to exempt tips and overtime from federal income tax. The devil, however, remains in the details as employers seek to implement these new rules.
How does the legislation exempt tips and overtime from federal income tax?
The Act enacts new section 224 of the Internal Revenue Code which provides a tax deduction of up to $25,000 per year for individuals receiving tips. New section 225 provides a similar deduction of up to $12,500 in overtime payments (or $25,000 in the case of joint filers).
Both deductions phase out $100 for each $1,000 the taxpayer’s modified adjusted gross income exceeds $150,000 (or $300,000 in the case of a joint return). So, for every $10,000 the taxpayer has in excess of $150,000 adjusted gross income, the taxpayer loses $1,000 of the new deduction.
Taxpayers must take the deduction for tips or overtime on their personal income tax returns. The deductions are above the line: taxpayers can take the deduction even if they do not itemize their deductions.
What tips are included?
Tip income means “cash tips” (tips paid in cash or charged) received by an individual in an occupation which customarily and regularly received tips on or before December 31, 2024. Tips or gratuities under most state and federal wage laws are usually reserved to individuals in occupations such as servers, bartenders, room service attendees, e.g., those who work at restaurants, bars, hotels, and customarily receive the tip directly from the customer. Tip income includes tips received as an employee as well as tips received in a separate trade or business, if the business generates taxable profits.
Certain professional service providers (e.g., health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services), do not receive the new tax deduction for tips.
What constitutes overtime?
“Qualified overtime compensation” means overtime compensation paid to an individual required under section 7 of the Fair Labor Standards Act of 1938 for hours worked in excess of forty (40) hours in a week. In those cases, the employee is due 50% more of his/her regular rate of pay per hour for the overtime hours worked that week.
Note, only the premium to the regular rate of pay is deductible under the Act. “Qualified overtime compensation” is defined as “overtime compensation paid to an individual required under section 7 of the Fair Labor Standards 10 Act of 1938 that is in excess of the regular rate (as used in such section) at which such individual is employed.”
Taxpayer Reporting Requirements
The taxpayer must report tip income to his or her employer monthly on IRS Form 4070, per the current tax guidelines. The taxpayer must include his or her social security number on his return to receive the tip or overtime deduction. If the taxpayer is married, he or she only receives the deduction if filing jointly with his or her spouse.
When does the deduction start?
The deduction starts for tips and overtime received in 2025 and is therefore retroactive. The deduction terminates, however, for tax years after 2028.
Employer and Third-Party Reporting Requirements
Tip Reporting Requirements. The Act requires employers to report on annual Form W-2s and 1099s a separate accounting of tip income paid to employees and contract workers and designate the occupation in which the employee/contractor received such tips.
The Act also requires third-party settlement organizations such as credit card companies and applications like Venmo and PayPal to report payments that have been reasonably designated by the payors as cash tips and report the occupation of the person receiving the tips.
The Act provides a transition rule for 2025 which allows tax reporters to approximate a separate accounting of amounts designated as cash tips.
To facilitate tip reporting, the Act requires the Secretary of the Treasury to publish a list of occupations which customarily and regularly receive tips for purposes of this new law.
Overtime Reporting Requirements
The Act likewise requires employers to report on annual Form W-2s the total amount of qualified overtime compensation paid to employees.
The Act provides a transition rule for 2025 which allows reporters to approximate a separate accounting of amounts designated as qualified overtime.
Extension of Social Security Tax Credit to Beauty Service Businesses
The Act also extends the federal income tax credit received by restaurant owners who report and pay payroll taxes on employee tips to beauty service businesses.
Upshot
The new law aims to provide a tax benefit to tip recipients and overtime workers. While the new law exempts such tip and overtime income from federal income tax, it does not exempt the income from payroll taxes.
The reporting requirements added are significant for a measure that is temporary. There could be more guidance on these changes coming from the IRS and the US Department of Labor. In the meantime, contact us with questions or to work through how to implement effectively these new requirements.
This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice.
Sandra is a member of the firm’s Corporate Group and an accomplished tax lawyer, who advises on matters pertaining to federal income tax in corporate mergers, acquisitions, joint ventures and planning initiatives, including the structuring of cross-border and IP buy-in transactions. Sandra’s bio can be found here.