The “No Tax on Tips & Overtime” provision, part of the One Big Beautiful Bill Act signed on July 4, 2025, has drawn attention for its potential payroll impact. While its title suggests a full exemption, it actually provides deductions that reduce taxable income rather than eliminating tax altogether. Tips may be deducted up to $25,000 annually and overtime up to $12,500 (for single) and $25,000 (for married filing jointly), for tax years 2025 through 2028.
Employers should prepare for payroll adjustments, benefit recalculations, and employee communication. Understanding the rule’s limits and requirements will be key to maintaining compliance and supporting both operations and staff.
What the “No Tax on Tips & Overtime” Proposal Means for Your Business
The law allows eligible workers to deduct certain tip income and overtime wages from their federal taxable income. It is not a full exemption. Instead, it reduces the amount of income subject to federal income tax.
- Tip income deduction: Up to $25,000 per year. For the employee to be able to claim the deduction, their W-2 must report the total amount of cash tips and the occupation of the employee who received the tips.
- Overtime pay deduction: Up to $12,500 per year ($25,000 for married filing jointly). For the employee to be able to claim the deduction, their W-2 must separately state the qualified overtime pay.
- Phaseouts: The deduction starts to phase out when modified adjusted gross income is above $150,000 ($300,000 for married filing jointly)
- Timeframe: Applies to tax years 2025 through 2028
Employers should also note that tips and overtime remain subject to Social Security and Medicare (FICA) taxes, and reporting obligations have not changed.
Potential Payroll and Compliance Impacts
Employers play a central role in implementing these changes. Areas to watch include:
- Payroll system adjustments: Software must be able to track deductible income separately from taxable wages.
- Benefit calculations: Retirement contributions, overtime multipliers, and wage-based benefits may shift depending on how taxable income is defined.
- Employee communication: Workers may assume “no tax” means complete exclusion. Employers will need to clarify that deductions apply only to income tax, not payroll tax.
- Multi-state operations: Some states may not conform immediately to the federal deduction, creating different payroll treatments across jurisdictions.
Actionable Steps to Prepare Your Business Now
- Review payroll software: Confirm that your provider can handle the new reporting requirements.
- Evaluate benefit formulas: Work with advisors to see if retirement or bonus programs need adjustments.
- Draft clear employee messaging: Be ready to explain how the deduction works, what qualifies, and what remains taxable.
- Stay updated on state responses: Monitor how Illinois and other states handle conformity to the federal deduction.
- Document payroll processes: Strong records will help in case of audits or employee disputes.
How DHJJ Can Help You Navigate Tax Law Changes
Tax policy changes rarely stop at one headline. Each adjustment influences payroll, compliance, and employee relations. At DHJJ, we translate new laws into clear action steps for business owners. Our team can help you evaluate payroll systems, plan for reporting changes, and prepare communications that build trust with your workforce.
The “No Tax on Tips & Overtime” deduction creates opportunities for employees and challenges for employers. Planning now can make implementation smoother and help your business stay compliant while supporting your team.
