The Highlights
- New Tax Break: Up to $12,500 in overtime pay is now tax-deductible for eligible workers.
- Employer Role: Employers must report FLSA overtime but do not determine employee eligibility.
- IRS Draft Forms: 2026 W-2 and W-2c include new boxes for overtime and tip reporting.
- Recordkeeping Alert: Expert advises employers to begin coding overtime types and tracking tip income now.
- Tip Reporting Expansion: Applies even to workers with ITINs; industry list still pending.
- Other Provisions: Includes expanded FICA tip credit, permanent FMLA credit, and new tip deduction occupation list.
Additional provisions include FICA Tip Credit Expansion, Permanent FMLA Credit, and a forthcoming Tip Deduction Occupation List.
Overtime Tax Exemption Prompts Industry-Wide Review
Following the enactment of the One Big Beautiful Bill Act (OBBBA, P.L. 119-21), payroll professionals are reviewing the operational impact of the law’s “no tax on overtime” provision. A recent discussion hosted by PayrollOrg revealed ongoing questions about how employers should identify and report qualifying overtime pay under the new rules.
The law allows individual taxpayers to deduct up to $12,500 in qualified overtime compensation from federal income tax, with a phase-out beginning at $150,000 in adjusted gross income. Employers are required to report total Fair Labor Standards Act (FLSA)-mandated overtime on Form W-2, but they are not responsible for determining employee eligibility based on income.
Employers Urged to Distinguish Overtime Types
Participants in the PayrollOrg community chat expressed concern about distinguishing FLSA-mandated overtime from other types of overtime. Employers are advised to begin coding overtime types in payroll systems to ensure accurate reporting for tax year 2025.
Deborah Walker, CPA and Director of Compensation and Benefits Consulting at Cherry Bekaert, emphasized the importance of early recordkeeping. “An employer should keep track of all Fair Labor Standards Act-mandated overtime for all employees, as the employer has no way of knowing what individuals will be able to avail themselves of this deduction,” Walker said. “The Adjusted Gross Income limitation is something that only the individual taxpayer will know and not something that any employer will want to know or the employee will want to share with the employer.”
Walker recommended that employers identify overtime types in payroll records as early as possible. “This can be done with codes in payroll tax records,” she said. “Identification of the types of overtime as early as possible in 2025 records will facilitate reporting for 2025 and later years.”
IRS Releases Draft Forms with New Reporting Boxes
The IRS has released draft versions of the 2026 Forms W-2 and W-2c, which include new reporting boxes for overtime and tip income. Box 12 will feature new codes:
- TT – Total qualified overtime compensation
- TP – Total qualified tips
- TA – Employer contributions to a Trump account
Box 14 has been split into 14a and 14b, with 14b designated for reporting Treasury occupation codes for tipped employees. These changes are designed to support new reporting requirements under the OBBBA. The IRS has confirmed that Forms W-2 for tax year 2025 will remain unchanged.
- Tip Reporting Requirements Raise Recordkeeping Concerns
Walker also addressed tip reporting requirements. “A service recipient with tipped workers should be keeping track of tip income and the time period for which the tips are paid,” she said. “This is because the statute requires reporting for 2025 and before HR 1 was enacted it was unlikely that such records were kept.”
She advised employers to maintain records of all payments that may be considered tips. “It is not yet clear exactly what ‘tip-like’ payments will be included,” Walker said. “For that reason, data of anything that may be considered a tip should be maintained.”
Walker noted that the IRS has not yet released the list of industries subject to the new tip reporting rules. “Service recipients of any workers receiving tips… should focus on maintaining whatever records of tip income exist,” she said. “Once the list of industries to which the tip reporting rules apply [is released], there will likely be an opportunity for the list to be supplemented.”
Additional Payroll Provisions Under the OBBBA
In addition to the overtime and tip provisions, the OBBBA includes several other payroll-related changes:
- FICA Tip Credit Expansion: The employer credit for Social Security taxes paid on tips now applies to additional occupations, including beauty service providers and food service workers.
- Permanent FMLA Credit: The tax credit for employers providing paid family and medical leave has been made permanent. Employers may now count state-mandated leave toward the credit.
- Tip Deduction Occupation List: The IRS is expected to publish a list of occupations eligible for the tip deduction. Employers are encouraged to submit suggestions to Treasury and the IRS to help shape the initial guidance.
Employers Encouraged to Prepare Systems and Records
Payroll professionals should monitor IRS updates and begin preparing systems and records to comply with the new requirements. As Walker concluded, “Maintaining the records that exist will better facilitate 2025 reporting.”
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