OBBBA Updates: Employer Reporting Obligations for Tips & Overtime

OBBBA or “H.R. 1” introduced major federal tax changes when it was signed into law on July 4, 2025. While headlines focused on “no tax on overtime” and “no tax on tips,” the law is much more nuanced, especially for businesses operating in California.

OBBBA created temporary federal income tax deductions for some overtime and tip income for tax years 2025 through 2028. Employees can claim these deductions when filing their federal income tax returns.

As an employer, your obligation is to report the qualified overtime and tips earnings to your employees, so they can then claim the deductions when they file.

Importantly, OBBBA’s rules on tips and overtime do not create exemptions from payroll taxes or change employer withholdings. Employers must still withhold and remit all required payroll taxes, including federal income tax, FICA, FUTA, California income tax, and California SDI/UI.

Recently, the IRS updated its guidance on which occupations are eligible to claim tip deductions. Keep reading for an overview and new, important information!

Overtime Deduction Rules

Under OBBBA, employees may deduct the premium portion of qualified overtime pay required under the Fair Labor Standards Act (FLSA). For example, when an employee works more than 40 hours in a workweek, they will earn time and a half under the FLSA. The additional “half” portion is what they are able to deduct.

The deduction is capped at:

• $12,500 for individual filers
• $25,000 for joint filers

Income-based phaseouts apply to higher earners.

For California employers, compliance is a bit more complicated because only overtime that qualifies under federal FLSA rules is eligible for the deduction. California-specific overtime requirements, such as daily overtime, double time, and seventh consecutive day overtime, do not qualify unless they also satisfy FLSA weekly overtime requirements.

As a result, employers may need updated payroll coding and tracking procedures to separate FLSA-qualified overtime from California-only overtime premiums.

Tip Deduction Rules

OBBBA also created a temporary federal deduction for qualified tips received in occupations that customarily and regularly received tips before December 31, 2024.

The IRS has now finalized the list of qualifying occupations, including tipped occupation codes for more than 70 qualifying occupations across eight categories, including:

• Beverage and Food Service
• Entertainment and Events
• Hospitality and Guest Services
• Home Services
• Personal Services
• Personal Appearance and Wellness
• Recreation and Instruction
• Transportation and Delivery

Mandatory service charges and automatic gratuities generally do not qualify as tips.

The tip deduction is capped at $25,000 annually and also phases out at higher income levels.

Employer Reporting Requirements

The IRS has now issued 2026 Form W-2 instructions implementing the OBBBA reporting changes.

Beginning with Tax Year 2026, employers will be required to separately report:

• Qualified overtime compensation
• Qualified tip income
• Treasury Tipped Occupation Codes (TTOCs) for eligible employees

The IRS also added new Box 12 reporting codes to help track overtime and tip amounts eligible for the federal tax deductions.

Bottom Line

Employer withholding obligations remain unchanged under OBBBA. The biggest impact for employers is payroll tracking and reporting, particularly for California employers navigating both state and federal overtime rules.

Now is a good time for employers to review payroll systems and reporting practices to ensure qualified overtime and tip income will be properly identified ahead of reporting for the 2026 tax year.