The “One Big Beautiful Bill Act” (P.L. 119-21), signed into law on July 4, 2025, introduces two major tax deductions for workers: one for tips and another for overtime pay. While the provisions are designed to boost take-home pay for millions of Americans, they also create new compliance burdens for employers-especially in hospitality, retail, and healthcare.
Gillian Florentine, a director with Baker Tilly’s Human Resources consulting team, says employers should take action now to prepare for the changes, which are retroactive to January 1.
What the law does
Under the new law, employees can deduct up to $25,000 in qualified tips and $12,500 in qualified overtime premiums from their taxable income. But the deductions are narrowly defined.
For overtime, only the “premium” portion-the extra half-time pay above the regular hourly rate-qualifies. Littler Mendelson offers this example: if an employee earns $20/hour and works 50 hours in a week, they receive 40 hours at $20 ($800) and 10 overtime hours at $30 ($300). Only the $10/hour premium for those 10 hours-$100 total-is deductible.
Florentine emphasized the importance of this distinction: “We are advising clients on both calculations as well as tracking tip information,” she said. “Particularly when there’s overtime, let’s say in hospitality where you’ve got both overtime and tips, to prevent some of the double dipping on the deductions.”
For tips, the law requires employees to report all tips as usual, but only a portion may qualify for the deduction based on income thresholds and annual caps. “Employees still are required to report all tips earned-that hasn’t changed,” Florentine explained. “But then what we’re going to need to see is a breakdown between the qualified and non-qualified tips so that employees, when remitting their personal tax returns, can actually make an accurate calculation of what deduction they’re able to take related to those tips.”
Readiness of payroll systems
Florentine said payroll vendors are still scrambling to update their systems. “It’s really early and the platforms that our firm has partnerships with are still actively in flight trying to configure their systems,” she said. “I suspect every other payroll platform provider is.”
She added that most systems likely won’t enforce the annual deduction caps ($25,000 for tips, $12,500 for overtime) or income thresholds ($150,000 individual / $300,000 joint). “I don’t think systems are going to max it out,” she said.
“I think what they’re just going to do is turn on the accumulator or track it so that then the employee is given the accurate year-end amount of total tips earned and then that total broken out by qualified and nonqualified tips and leave it up to the employee on their personal tax return depending on how they’re filing,” Florentine speculated.
Retroactive application and year-end reporting
Because the law applies retroactively to January 1, 2025, employers may need to adjust previously processed payrolls. “There is a provision for making an assumption this year,” Florentine said. “That gives individual employees and employers a little bit of leeway.”
She doesn’t expect a spike in corrected Forms W-2c this year, but warned that 2026 could be different. “I would guess in tax year 2026 we might see an uptick there,” she said.
Potential IRS form changes and guidance
As of mid-July, the IRS has not issued formal guidance on these provisions. “Nothing exists on the IRS website as of today,” Florentine said.
That said, she assumes changes to IRS Forms W-2 and possibly 4137 to accommodate the new reporting requirements. “I can’t see how the W-2 won’t be changed,” she said. “Employers now need to know of those tips, what’s qualified and what’s not.”
She posited that the W-2 may eventually include new boxes or codes to distinguish between qualified and non-qualified tips and overtime. However, she expressed concern about whether payroll platforms will have enough time-or technical clarity-to implement those changes for the 2025 tax year.
“I’m not sure how that will be accomplished in payroll platforms yet,” she said. “We’ll even need to know what to do to adjust the W-2s so that those come out correctly with a new box.”
She was less certain about Form 1099, noting that independent contractors already self-report income. “I think the 1099 will be less impacted,” she said.
The Act of 2025
Keep your firm ahead of the curve. Our 55-page special report provides the authoritative analysis you need.
Get the report ↗What employers should do now
Florentine urged employers to begin preparing immediately. “We’re certainly talking with [hospitality clients] now about…[building] ways in the meantime to track [qualified and non-qualified tips the] best we can,” she said.
She also recommended internal assessments-even if not formal audits-to validate payroll data. “Anytime there is a regulation change as sweeping as this, it is a good time to cross-check and validate what we are tracking,” she said. “Start parsing out some of those totals or sums that are probably tracked somewhere but aren’t split out by these qualified and unqualified [categories] or what counts towards no tax on overtime.”
She emphasized the need for collaboration across departments. “Payroll has a tie into accounting… and tax departments altogether to make sure employers understand what is the ripple effect,” she said.
Communicating with employees
Florentine said employers should proactively communicate with workers. “There’s a group of employees that pay attention to that kind of thing, and then a big group that just assumes their paycheck is correct,” she said. “The more proactive in the communication, obviously, I think the better.”
She added: “Getting in front of it helps. Having that open dialogue is a good protocol by an employer.”
Industry-specific considerations
The law is not intended to apply uniformly across all sectors. “The regulation does call out certain industries that this is not meant to target, especially in the tips world,” Florentine said. “Certainly, hospitality and some retail [are included], but we’ll have to see how the IRS continues to develop their guidance on that in all industries and how it impacts.”
Risk of abuse
Florentine acknowledged the potential for abuse. “Any regulation as it relates to tax, you’re always going to have either individuals or organizations that are going to find a way to work that to their advantage – either right or wrong,” she said.
She pointed to the temporary flexibility built into the law for 2025 as a potential opening for abuse. “This year in particular will be interesting because there is the leeway to say assumptions can be made,” she said.
“For example, the tips this year-as an individual, I can’t imagine why an individual wouldn’t say, ‘Well, I’m going to say my estimation is exactly what the deduction allows me to take.'”
She stressed that in the absence of IRS guidance, “You will always have players that take regulations to the limit.”
What’s next
Florentine said her team is in constant communication with payroll vendors and clients. “This is a very, very relevant topic. We’re literally talking about this every day,” she said. “We’re trying to do our best to be on the forefront of understanding what’s the latest.”
She noted with regard to any federal agency action, “It’s still early. In the meantime, Florentine recommends that employers focus on preparation and communication.
“Start tracking what you can now,” she advised. “Even if you don’t have all the answers, having a system in place to capture qualified and non-qualified tips and overtime will put you in a better position when the IRS guidance does arrive.”
Her message to employers: stay alert, stay flexible, and stay in touch with your payroll and tax advisors. “Now we’re starting to get some real traction on how this is gonna work,” she said. “And now what do we do? That’s the developing part.”
 |
|
