Following the July 4 enactment of the One Big Beautiful Bill Act (P.L. 119-21), payroll professionals began closely reviewing the legislation’s implications—particularly provisions related to the federal income tax treatment of certain tip and overtime wages. The large tax reform law introduced new sections to the Internal Revenue Code, prompting a surge of discussion within PayrollOrg’s online community—a nonprofit association that supports payroll professionals through education, advocacy, and industry resources.
Among those contributing to the ongoing conversation is Jim Medlock, CPP, a payroll professional with nearly five decades of experience. While Medlock currently serves as President-elect of PayrollOrg, he has been offering insights for decades, drawing on his long career as PayrollOrg’s Director of Education and Training, and since his retirement, as a payroll educator at Medlock and Associates.
In a recent interview with Checkpoint News, Medlock shared his own perspective on several key issues raised by the legislation, including compliance and reporting challenges, as well as the potential for employee confusion as payroll teams work to interpret and respond to the law’s various payroll-related provisions.
Misleading Labels, Misunderstood Provisions
Medlock said the most immediate source of confusion from the Act stems from the titles of two high-profile provisions: “No Tax on Overtime” and “No tax on Tips.”
“Neither title adequately describes what is required in the actual law,” Medlock said. “They would be better titled as ‘No Tax on Some Tips’ and ‘No Tax on Some Overtime.'”
Contrary to what the names suggest, Medlock explained that these wages are not exempt from payroll tax withholding and must still be reported on Form W-2. Instead, employees may deduct certain qualified amounts on their personal income tax returns, typically on Form 1040.
Overtime Deduction: Limited Scope, Broad Confusion
The overtime deduction is limited to the 50% premium required under the Fair Labor Standards Act (FLSA), not the full amount of overtime pay. For example, an employee earning $20 per hour who works 42 hours in a week would receive $60 in overtime pay. However, only $20—the 50% premium—is deductible.
“Employees will also expect to look at what their payslip says for overtime, which will be the deduction they use on their 1040,” Medlock said, adding that these provisions were not explained in enough detail throughout the legislative process, which will add more confusion going forward.
In states like California, where overtime is calculated based on daily hours rather than weekly totals, employees may receive overtime pay that does not qualify for the federal deduction. Medlock said this could lead to frustration among employees expecting larger tax benefits and again stressed the need for clarity and clear communication on this provision.
Tip Deduction: Narrow Eligibility and New Reporting Burdens
Only certain types of tips—specifically cash tips and those received through tip pooling arrangements—are eligible for the deduction. Tips derived from service charges, which are often distributed to employees as part of their paycheck, do not qualify.
“A similar situation will be seen by tipped employees,” Medlock said, “as only ‘cash tips’ and tips received from a tip pooling arrangement can be deducted on the employee’s 1040.”
The deduction is also limited to occupations that customarily received tips as of December 21, 2024. The IRS is expected to publish a list of qualifying occupations by October 2, 2025. Employers will be required to report both the amount of tips and the employee’s occupation on Form W-2.
Retroactive Effective Date Raises Implementation Concerns
Medlock noted that the retroactive effective date of January 1, 2025 for these provisions may also create significant challenges for payroll professionals who have already processed more than half a year’s worth of payroll.
“Payroll professionals have been processing weekly, biweekly, and/or monthly payrolls since January 1, 2025,” Medlock said. “Significant changes must be made to payroll applications to produce compliant Forms W-2 for distribution to employees in January 2026.”
Without accurate reporting, employees may not be able to claim the deductions. Medlock warned that the short timeline and complexity of the law leave little room for error or delay.
“Unfortunately, when the law was enacted 184 days into 2025, only 179 days were left to understand the law entirely, identify overtime paid that the FLSA does not require, identify service charges that were included in employee tips, then have the payroll application providers modify their systems and provide tools required to segregate overtime required by the FLSA and non-FLSA overtime,” he added.
Short-Term and Long-Term Compliance Challenges
In the short term, Medlock said the biggest challenge is the need to retroactively identify and report qualified tips and overtime on 2025 Forms W-2. For tips, employers must distinguish between deductible cash tips (including credit card tips) and non-deductible service charges. The law also requires reporting the employee’s occupation, raising questions about how to handle employees who change roles during the year.
Looking ahead, Medlock said the long-term challenge will be maintaining accurate W-2 reporting through 2028, when the provisions are scheduled to expire. This will require ongoing system updates and careful tracking of eligible wages.
IRS Guidance Needed on Withholding and Reporting
Payroll professionals are also awaiting IRS information on how to implement the new provisions. The only guidance from the agency so far has been an overview of the new “No Tax on Overtime” and “No Tax on Tips” provisions, issued on July 14, 2025. More is expected, and Medlock said two areas are of particular concern.
“First, they need transition rules for reporting qualified tips and overtime on 2025 Forms W-2, especially since most payroll systems currently do not separate these amounts,” he said. “Flexibility in how these amounts are identified and reported will be important.”
Second, there are questions about how federal income tax withholding will be handled from 2026 through 2028. Medlock said professionals want to know whether employers will be allowed to reduce taxable wages for withholding purposes or if employees will need to estimate their deductions using a revised Form W-4.
1099 Threshold Increase Expected to Have Minimal Impact
The law also raises the reporting threshold for Forms 1099-MISC and 1099-NEC from $600 to $2,000, effective January 1, 2026. However, Medlock said this change is unlikely to significantly alter current practices.
“Many organizations already request Forms W-9 from any vendor that is potentially going to be paid $600,” he said. “They will likely continue to use the same procedure.”
Broader Tax Changes May Be More Favorably Received
While the tip and overtime provisions have generated concern, Medlock said other elements of the law are likely to be more positively received by employers and employees. These include:
•An increase in the annual exclusion for dependent care assistance under IRC Section 129 from $5,000 to $7,500—the first permanent change since 1986.
•Inflation adjustments to IRC Section 127 exclusions for employer-provided student loan payments and educational assistance, marking the first increase in the $5,250 exclusion since 1978.
•An increase in the employer credit for childcare expenses from 25% to 40% of qualified costs.
Medlock also noted that the expanded employer credit for childcare and the paid family and medical leave credit are the only benefit-related provisions in the law expected to directly affect employer tax returns. Starting in 2027, employers will also need to assess whether their educational assistance and student loan repayment benefits should be adjusted for inflation.
Payroll’s Role in Employee Communication
As employees begin to notice that their overtime and tips are still subject to withholding, payroll professionals are fielding questions and working to clarify the law’s provisions.
“Payroll professionals are developing FAQs to explain these provisions, as they have been very poorly described,” Medlock said. “The time required to explain to employees why their withholding has not decreased will take time from making the necessary changes to comply with the new 2025 reporting requirements.”
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