On July 4, 2025, new federal tax legislation was signed into law. Informally referred to as the “Big Beautiful Bill” during its development, the law’s official title is Public Law 119-21. One of the most notable provisions provides temporary tax relief for tipped and overtime-eligible workers, applying to wages earned from January 1, 2025, through December 31, 2028.
While the promised tax savings are significant, employers are still waiting on formal IRS guidance about how to implement the changes. Here’s what we know so far—and what your business can do now to stay compliant.
The intent of this provision of OBBB is to provide temporary tax relief to lower-wage workers. Tipped employees can deduct up to $25,000 in tips from their income, subject to federal income taxes, although they still must be reported on Form W-2. Similarly, employees who receive overtime pay can deduct up to $12,500 in overtime pay from their incom,e subject to federal income tax with the amount reported on Form W-2. Workers who are contractors will need to have their tips and overtime reported separately on Form 1099-NEC.
Workers who are eligible can claim these deductions on their personal tax returns, and do not need to itemize to do so.
This measure is retroactive and applies to tips and wages already paid out in 2025. FICA contributions are not affected, and still must be made on tip income and overtime pay. State income taxes are also not affected.
The IRS has not yet issued formal guidance on how to navigate changes to payroll tax reporting.
There are plans to issue formal guidance by the fall of 2025, with the IRS publishing a list of tipped occupations by October 2, 2025. Tipping is the most common in restaurants, hospitality, and personal services such as beauty salons and tattoo parlors. However, as many critics of tipping culture have pointed out, more establishments outside of food and personal services now expect tips. A list of tipped occupations can narrow down which industries are officially subject to this new regulation.
There will be new reporting requirements for employers on the list of tipped occupations. However, transitional relief is also promised as this provision is retroactive and the implementation is very sudden.
If you have tipped employees, you may be eligible for the FICA tip credit. As the law is currently written, the only covered employers are in providing, delivering, or serving food and beverages. OBBB expands FICA tip credit eligibility to include personal care businesses like spas, nail salons, and barbers where tipping is customary. It is not year clear if this amendment to the FICA tip credit will be permanent.
While the FICA tip credit expansion only applies to food and personal services, the list of tipped occupations will determine which employers will be obligated to change their payroll reporting.
Employers of workers who are eligible for overtime compensation will need to report the amount of qualified overtime, which is only excessive hours under the Fair Labor Standards Act and does not include overtime premiums required under state laws or collective bargaining agreements.
The IRS will change withholding rates and this may be difficult to implement for retroactive pay in the first half of 2025. HR teams will also need to create additional mechanisms for tracking eligible compensation types, and when employees potentially lose their eligibility. Even if an employee earns too much in tips or overtime to qualify for the deduction, employers are still obligated to report these amounts and use the new withholding tables.
Employers who wait too long to transition their payroll reporting systems may be at risk of noncompliance if there is a short or unclear transition period.
While awaiting formal guidance from the IRS, there are actions you can take right now.
Review your current reporting of tips and overtime pay, and flag the types of compensation that may be affected. It's also wise to speak to your employees about the changes in the law, and what they can expect in the near term and after the law is fully implemented.
They may hear on the news that they don't have to pay taxes on tips and overtime, but are surprised to see they still paid some tax. They should be aware of any reporting changes that will immediately affect their take-home pay.
Partnering with a payroll provider like Exact Payroll helps your business stay flexible as laws frequently change, and compliance challenges need to be overcome. Stay ahead of the curve. Contact Exact Payroll to get personalized support as the IRS releases new compliance requirements for the 2025 tax law.