On July 4, 2025, President Donald Trump signed the "One Big Beautiful Bill" into law. Among its sweeping provisions are two significant changes for wage and hour compliance that employers should be aware of: the creation of federal income tax deductions for employee tips and certain overtime compensation. Both changes are poised to impact businesses and workers beginning in the 2025 tax year and lasting until 2028.
No Tax on Tips
Previously, the IRS treated all voluntary cash and non-cash tips as taxable income that was required to be reported to employers monthly. However, effective January 1, 2025, employees who "customarily and regularly received tips on or before December 31, 2024," may now deduct up to $25,000 in tips from their federal taxable income. This deduction phases out for earners whose adjusted gross income exceeds $150,000, reducing the deduction by $100 for each $1,000.
No Tax on Overtime
The Bill also establishes a tax deduction for "qualified overtime compensation," defined as "overtime compensation paid to an individual required under Section 7 of the Fair Labor Standards Act [(FLSA)] that is in excess of the regular rate." Employees may deduct $12,500 in qualified overtime pay from federal taxable income. Similarly, this deduction phases out for earners whose adjusted gross income exceeds $150,000.
Note: This deduction does not apply to overtime required under state laws or collective bargaining agreements.
What Employers Need to Know
These deductions are in addition to the standard deduction for individual income tax filers and require updated payroll reporting practices. To ensure compliance, employers must:
- Ensure accurate tracking of tips and qualified overtime compensation;
- Report the total amount of tips and/or qualified overtime compensation on Forms W-2 and 1099; and
- Include occupation details of the recipient on the applicable tax form.
The IRS will provide transition relief for the 2025 tax year to employers subject to these new reporting requirements. Although the IRS has not yet issued formal guidance, the KMK Labor & Employment Team is closely monitoring developments and will provide updates as regulatory guidance becomes available. In the meantime, employers should begin reviewing their reporting practices to prepare for compliance in the 2025 tax year.
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