February 19, 2026
By Newburg | CPA Staff
As part of the recently enacted One Big Beautiful Bill Act (OBBBA, P.L. 11921), significant federal tax changes are on the horizon for employers, employees, and payroll systems. These updates—effective 2025 through 2028—introduce new deductions for workers who earn tips or overtime, as well as new reporting obligations for employers beginning in 2026.
Below is an overview of what these rules mean and the steps your business should take to prepare.
1. New Above-the-Line Deductions for Tips and Overtime
Beginning in tax year 2025, eligible employees may claim new deductions on their federal tax returns:
Qualified Tips
Employees (and certain nonemployees) working in occupations that customarily and regularly received tips as of December 31, 2024, may deduct up to $25,000 of qualified tips per year.
Qualified Overtime Compensation
Employees may deduct up to:
- $12,500 for single filers
- $25,000 for married filing jointly
Only the FLSA mandated overtime premium—generally the “half” in “time and a half”—is deductible.
Overtime paid solely under state law or company policy does not qualify.
Income Limits and Eligibility
The deductions phase out at $100 for every $1,000 of MAGI above:
- $150,000 for single filers
- $300,000 for joint filers
Additionally:
- Married couples must file jointly to claim either deduction.
- The taxpayer (and spouse, if applicable) must have a valid Social Security number.
2. New Payroll and Reporting Requirements for Employers
Updated Forms W2 and 1099 (Beginning 2026)
Employers will need to separately report:
- Total qualified tips
- Total qualified overtime compensation
- The employee’s occupation
These changes apply to both Forms W-2 and applicable 1099 forms.
Transition Relief for 2025
For tax year 2025, the IRS will not penalize employers for failing to separately report these categories. Forms will be updated starting in 2026, but employers should still maintain accurate yearend records to assist employees when claiming deductions.
Payroll System and Recordkeeping Changes
Employers should begin working with payroll providers now to ensure systems can:
- Track cash tips separately
- Track FLSA mandated overtime premiums
- Capture occupational data for reporting
Providing employees with detailed yearend statements for 2025 is strongly encouraged.
Withholding & FICA
These new deductions do not affect payroll withholding:
- FICA taxes still apply to all tips and overtime.
- Federal income tax withholding remains unchanged; employees will claim the deductions on their individual returns.
3. Key Considerations for Employers
Eligibility Rules
- Only customarily tipped occupations qualify for the tip deduction.
- Automatic gratuities and service charges do not qualify as tips.
- Only the FLSA overtime premium qualifies.
Employee Communication
Now is the time to educate employees on:
- What qualifies and what doesn’t
- The importance of accurate tip reporting
- What documentation they may need at year-end
State Tax Treatment
These deductions apply only at the federal level.
State and local tax treatment remains unchanged.
Temporary Rules
Unless extended by Congress, these deductions expire after tax year 2028.
4. Action Steps for Employers
To prepare for the upcoming transition, employers should:
- Review current payroll practices to identify necessary updates for tracking qualified tips and FLSA overtime.
- Coordinate with payroll providers to ensure systems are ready for the new reporting requirements in 2026.
- Train HR and payroll teams on the new rules and required documentation.
- Monitor IRS announcements for updated forms, instructions, and guidance.
The One Big Beautiful Bill Act (OBBBA) represents a significant change in federal tax legislation. Newburg | CPA is available to help you understand these provisions and their potential tax implications. Contact us at info@newburg.com.