By Tina Kelly, Manager, Accounting Services
[email protected]
Key Points
- The One Big Beautiful Bill (OBBB) introduces new payroll reporting requirements beginning in 2025.
- Employers must track and report qualified overtime and tip income separately on employee W-2s.
- Early preparation will help ensure compliance and prevent reporting errors in 2026.
What Is Changing Under the OBBB Payroll and Overtime Rules?
The OBBB introduces new payroll reporting requirements that focus on accuracy and transparency. Beginning in 2025, employers must track the FLSA overtime premium portion, which is the additional 0.5 rate paid for hours worked over 40 in a week.
Many employers are still unaware that these new requirements apply to them. Failing to prepare could result in inaccurate W-2s, rejected filings, and potential penalties.
Non-exempt employees can deduct this premium portion on their federal tax returns through 2028, with a cap of $12,500 for single filers and $25,000 for joint filers. These deductions phase out for individuals with higher incomes.
The OBBB does not change FLSA overtime thresholds, salary tests, or payroll taxes. It does require employers to distinguish between qualified federal overtime and any state or contractual overtime that does not qualify for the deduction.
When Do Employers Need to Start Reporting These Changes?
Employers have been required to track qualified overtime and tip income since January 1, 2025. The first stage of reporting occurs on 2025 W-2s, which must include qualified overtime and tip amounts in Box 14.
Beginning January 1, 2026, the IRS will require employers to use new Box 12 codes on employee W-2s: “TT” for overtime and “TP” for tips. Employers should not use the 2026 codes on 2025 forms, as W-2s will be rejected if filed incorrectly.
The Treasury Department released its draft list of tip-eligible occupations in October 2025, which is now awaiting final approval. Employers in service-based industries should review the list and ensure their payroll systems are ready to report these amounts in early 2026.
Which Businesses Will Be Most Affected by These Changes?
Employers with a high number of hourly, non-exempt employees will experience the most significant impact. This includes industries such as manufacturing, logistics, health care, hospitality, and retail.
Multi-state employers will also face added complexity since some states define a workweek differently or apply additional overtime rules. Unionized workplaces will need to separate FLSA overtime from contractual pay that does not qualify for the deduction.
Employers using outdated payroll systems may need to update their software to ensure accurate reporting.
What Should Employers Know About the New Tip Deduction?
The OBBB introduced a new federal deduction for qualified tips that applies to specific service-based occupations. The Treasury’s draft list includes:
- Food and beverage workers such as servers, bartenders, and baristas
- Personal services providers such as hairstylists, manicurists, and massage therapists
- Hospitality and home service workers such as hotel staff, housekeepers, and valets
- Transportation and delivery workers, such as rideshare and delivery drivers
- Entertainment and digital content creators
This list is preliminary and subject to change before final approval. Employers in affected industries should begin tracking tips now to prepare for accurate W-2 reporting in 2026.
What Steps Should Employers Take Now to Prepare for Compliance?
Employers should use the remainder of 2025 to strengthen payroll systems and ensure accurate tracking for 2026. Encourage employers to verify that their payroll systems or providers are already preparing for the transition.
For in-house payroll:
- Review employee classifications to confirm exempt and non-exempt status.
- Update payroll and timekeeping systems to identify qualified overtime.
- Begin tracking qualified tips for eligible occupations.
- Maintain documentation showing how overtime and tips are calculated.
- Train payroll staff to understand new reporting requirements.
If you outsource payroll:
- Ask your payroll provider to confirm that qualified overtime and qualified tips are being tracked separately.
- Verify that 2026 W-2 Box 12 codes TT and TP will be supported and tested.
- Request a sample year-end report that shows how qualified amounts will appear on W-2s.
Employers should continue their normal FICA, FUTA, and income tax withholding practices, as these rules remain unchanged.
How Can Your Accountant Help?
Your accounting advisor can walk you through these updates, verify that your payroll systems meet OBBB requirements, and help interpret how federal and state rules overlap. Treating these changes as a planning opportunity can lead to stronger systems and a more strategic approach to managing your team.
Frequently Asked Questions (FAQ’s)
Do the OBBB provisions change how employers calculate or pay overtime?
No. Employers must continue following existing FLSA standards and pay overtime as usual. The OBBB only changes how qualified overtime is tracked and reported for tax purposes.
What happens if an employer does not properly separate qualified overtime and tips in their payroll system?
If qualified overtime and tips are not tracked accurately, W-2s may be filed incorrectly or rejected, and employees could lose access to the related deductions. Proper system configuration and documentation are essential to ensure compliance.
How long will these new reporting requirements and employee deductions remain in effect?
The overtime and tip reporting provisions are scheduled to remain in place through December 31, 2028. Employers should plan for annual compliance unless new legislation changes or extends the timeline.
Have Questions About Preparing for OBBB Payroll and Overtime Updates?
Now is the time to review your payroll systems and finalize your readiness for these new requirements. Contact Tina Kelly at [email protected] to ensure your business is prepared for accurate and compliant reporting in 2026.