OBBBA Overtime and Tips: 2025 and 2026 Implementation Guide for Small Businesses

The IRS recently issued guidance and transition relief for the One Big Beautiful Bill Act (OBBBA) that introduces significant changes for employers with tipped and overtime-eligible employees. These updates impact payroll documentation, year-end reporting, and how employees will claim new tax deductions tied to qualified tips and qualified overtime.

Some changes are already in effect in 2025 and apply to year-end reporting you’ll produce in early 2026. Other requirements will begin in 2026. If your business operates in an industry where overtime or tipping is common, these rules will likely affect your workforce.

This guide breaks down what small and mid-sized employers need to know, including:

• What’s changing due to OBBBA
• What employers should know about qualified tips
• What employers should know about qualified overtime
• How to prepare for 2026 requirements
• Practical payroll and reporting tips for OBBBA compliance

What the OBBBA Changes

For eligible employees, the OBBBA allows a deduction of qualified tips and qualified overtime premium pay from federal taxable income, effective starting with the 2025 tax year. Employees will claim deductions when preparing their annual personal tax returns. These deductions reduce their personal tax liability, but they do not change how employers withhold taxes each pay period.

For employers, the OBBBA mandates new IRS reporting and payroll documentation standards starting January 1, 2026, requiring that these amounts be reflected on Form W-2. Employers must also maintain detailed supporting records.

These changes will require your business to take key actions:

• 2025 — Estimate and document qualified amounts using reasonable methods. The IRS is offering transition relief for the 2025 tax year, which means new reporting penalties will not apply as businesses adjust to the new rules.
• 2026 — Begin accurate tracking and reporting based on updated Form W-2 instructions and final IRS rules. You may need to update your payroll and recordkeeping processes so these amounts are captured and reported consistently.

IRS guidance released in late November provides important updates for small businesses to keep in mind:

• Payroll systems must begin tracking these categories separately for 2026 reporting on Form W-2. Draft W-2 instructions show new codes (“TP” for qualified tips and “TT” for qualified overtime) and a new box for Treasury Tipped Occupation Codes (TTOCs).
• The deduction for qualified overtime and qualified tips is temporary, applying to tax years 2025 through 2028.
• These deductions are subject to income-based phase-outs for high earners.

Qualified Tip Deductions: What Employers Should Know

Under OBBBA, eligible employees can deduct up to $25,000 of qualified tips on their personal federal tax return each year (with phase-outs for high earners).

What are Qualified Tips?

A qualified tip must meet the following IRS and Treasury definitions:

• It must be voluntary. Mandatory service charges, gratuities automatically added to a bill (such as for large parties), and tips customers are forced to give (such as through a pre-filled computer screen) are not considered voluntary.
• It must be paid in a customarily tipped occupation, as defined by the Treasury Tipped Occupation Codes (TTOCs).
• It may be received via cash, credit card, gift card, or cash-equivalent form.
• It includes tips received through tip-sharing arrangements.
• It excludes receipts from automatically applied service charges and tips received in certain specified service trades or businesses (SSTBs). Examples of SSTBs include businesses providing services within the fields of law, health, athletics, and investment management.

Industries Covered by TTOCs

The Treasury released a set of eight major occupation categories that qualify for the deduction. These range from food service and hospitality to recreation and personal appearance. Examples include:

• Servers and bartenders
• Salon and spa workers
• Delivery drivers
• Recreation and instruction staff
• Entertainment and event workers

These codes will eventually appear on Form W-2 once final IRS forms are released. An early release of the 2026 Form W-2 draft indicates a new Box 14b will be added to list the TTOC code.

Documentation Requirements for 2025

Until final regulations take effect in 2026, employers may use any reasonable method to estimate qualified tips, including:

• Total Social Security tips reported in Box 7 of the W-2.
• Tips reported via Form 4070 or equivalent records.
• Cash tips voluntarily reported on paycheck stubs or W-2 Box 14.
• Unreported tips captured on Form 4137.

The IRS will not penalize employers for missing separate accounting in 2025 due to the phased implementation of OBBBA.

Qualified Overtime Deductions: What Employers Should Know

Eligible employees may deduct only the FLSA-required overtime premium pay — not the entire overtime wage — from their taxable income. Employees will take this deduction on their personal tax return, not through payroll. The maximum deduction is $12,500 for single filers or $25,000 for joint filers.

What Counts as Qualified Overtime?

• Only the premium portion (the “half time” in a 1.5x scenario) qualifies for the overtime deduction.
• Only nonexempt, FLSA-eligible employees may claim the deduction.
• Overtime exceeding FLSA requirements does not qualify. Examples of non-qualified overtime include double-time voluntarily provided, additional OT required under state law, or collectively bargained premiums that exceed federal requirements.

Example: How the Qualified Overtime Deduction Works

Your employee earns $15.00 per hour and works overtime, which is paid at 1.5 times their hourly wage.

• Regular rate: $15.00 per hour
• Overtime rate: $22.50 per hour

Qualified OT premium: To calculate the premium, subtract the regular rate from the overtime rate.

• $22.50-$15.00 = $7.50

In this case, $7.50 of the hourly overtime pay qualifies for the deduction.

For more information on calculating overtime pay, visit the Department of Labor’s FLSA Overtime Calculator Advisor.

How to Estimate Qualified Overtime for 2025

Because detailed reporting doesn’t take effect until 2026, the IRS allows reasonable methods for reporting qualified overtime in 2025, such as:

• When overtime is shown separately on pay records, use the exact premium amount.
• If pay records only show a total overtime wage, divide the amount by 3 (for 1.5x pay) or 4 (for 2x pay), as long as this produces a reasonable approximation.

Retain payroll records, invoices, and any backup documentation supporting how these numbers were estimated.

What’s Changing in 2026 (and What Employers Should Expect)

While 2025 is a transition year with penalty relief, reporting is mandatory for the 2026 tax year (i.e., for W-2s issued early in 2027). Beginning January 1, 2026, the OBBBA requires you to adjust payroll and reporting methods to account for these changes.

1. Updated W-2 reporting

While the early release draft of the 2026 Form W-2 (that will be issued in early 2027) is still subject to official approval, the draft provides direction on where reporting is headed. IRS instructions on the draft show:

• Box 12 codes “TP” (qualified tips) and “TT” (qualified overtime)
• Box 14b to capture each employee’s TTOC

2. Accurate, itemized payroll tracking

To ensure compliance, you will need to track:

• Total qualified tips
• Total qualified overtime premiums
• The employee’s tip-qualifying occupation code (TTOC)
• Supporting records for how these amounts were calculated

3. No more reliance on estimates

Once final rules are in place, you must provide actual amounts for qualified tips and qualified overtime compensation on Form W-2. Incorrect or missing reporting may result in penalties. Current IRS guidance indicates employers can be subject to section 6721 and 6722 penalties for incorrect or incomplete returns and payee W-2 statements, which can range from $60-660.

4. Continued withholding obligations

Though employees may be eligible for these new deductions, you are still required to withhold income taxes and FICA taxes on all wages, including tips and overtime. Employees claim the tax deduction when they file their year-end tax returns.

How Employers Should Prepare Now

Taking a proactive approach to tracking and documenting qualified overtime and qualified tips will help you prepare for new requirements in 2026. Increase your chances of a smooth transition by following these steps:

2025: Documentation and Estimation Phase

• Estimate qualified overtime and qualified tips using reasonable methods.
• Existing W-2 formats remain in place.
• IRS will not penalize employers for missing separate tip/overtime amounts.
• Employees must review estimated W-2 amounts before using them to claim deductions.

2026: Reporting and Payroll Tracking Phase

• New reporting requirements, such as Box 12 codes and TTOCs, will take effect once finalized by the IRS.
• You must implement accurate payroll coding for qualifying compensation.
• Supporting documentation requirements become stricter.

2027–2028: Continuation of OBBBA Deductions

• No additional employer changes are expected, but you must maintain compliance with the new reporting structure and stay alert for any further developments.
• These deductions expire after the 2028 tax year, unless extended.

Practical Payroll and Reporting Tips for OBBBA Compliance

Use these practical tips to help your business bridge the gap between current relief and upcoming mandatory reporting standards.

1. Review how your business currently tracks tips and overtime.

If your business relies on manual processes or integrations with other systems, you may need to adjust workflows to capture qualifying categories separately. Requiring employees to submit a daily tip form will help ensure proper documentation. Distinguishing between qualified and non-qualified tips will also be key. A premium overtime calculation log or worksheet can also make it easier to differentiate between premium overtime and regular wages.

2. Identify employees who fall under Treasury Tipped Occupation Codes.

The preliminary TTOC list released by the Treasury Department and IRS includes codes for occupations that “customarily and regularly received tips prior to December 31, 2024.” The TTOC codes will be required for Form W-2 reporting starting with 2026 tax forms. Businesses can use this list for planning purposes, but the list is still under review and subject to change.

3. Maintain detailed documentation.

Accurate records will become critical in 2026 once estimation relief ends for the 2025 tax year. Consult with your tax professional to ensure your reporting systems are compliant before the 2026 filing season begins. If you outsource HR or payroll to a third party, discuss with your provider how they are proactively preparing and how HR technology or processes will change to ensure accurate recordkeeping and documentation.

4. Proactively communicate with employees.

Employees may have questions about how these deductions work and the impact on their paychecks and tax returns. Share resources that explain what is changing and what they can expect.

5. Watch for final IRS regulations.

Keep an eye out for final IRS rules and updated tax forms under OBBBA. Final rules may fine‑tune which jobs qualify and exactly how tips and overtime will appear on W‑2s and 1099s.