2025 Tax Law Changes: What Employers Need to Know About Tip and Overtime Deductions

The Biggest Changes

The OBBBA introduces changes to tax benefits and reporting requirements that affect different classes of employees. Among its most significant features are two new deductions:

• A deduction for tipped employees that allows workers to claim up to $25,000 in qualifying tip income.
  
  
• A separate deduction for the premium portion of overtime pay, targeting non-exempt employees under federal labor law.
  
  

Both deductions apply retroactively from January 1, 2025, and are available through 2028, unless extended or made permanent.

Understanding the Tip Income Deduction

For the first time, employees who earn tips can deduct a portion of their income directly from their taxable federal income—up to $25,000 per year. The deduction is above-the-line, meaning it’s available to all qualifying taxpayers, whether or not they itemize.

However, not all employees will qualify. The deduction phases out for individuals with income above $150,000 (or $300,000 for joint filers). And while federal tax liability may decrease, employees will still pay Social Security, Medicare, and applicable state and local taxes on the full amount of their tip income.

Employers should note: This new deduction will require updated W-2 reporting, including new boxes that specifically track tip income.

The Overtime Premium Deduction: A Closer Look

This deduction targets the “premium” portion of overtime—meaning the extra pay employees receive above their standard hourly rate for working over 40 hours per week.

For example, if an employee earns $20/hour and receives $30/hour for overtime, only the $10/hour premium is deductible under the new rule.

To qualify, workers must:

• Be classified as non-exempt under the Fair Labor Standards Act (FLSA)
  
  
• Receive overtime pay based on federal (not state or contract-based) standards
  
  
• Be classified as W-2 employees—independent contractors are excluded
  
  

Just like with tip income, the deduction is capped at $12,500 for single filers and $25,000 for married couples filing jointly, and phases out for high-income earners.

Notably, this deduction doesn’t apply to overtime earned through union contracts, employer policies, or state-specific labor laws. Daily overtime or other non-standard calculations are also excluded.

What Employers Should Do Now

To ensure compliance—and to help employees take advantage of these new deductions—employers must take proactive steps now. Start by reviewing your payroll systems. Most businesses will need to update how tip income and overtime premiums are tracked and reported.

Meet with your CPA or payroll provider to ensure your current setup will accommodate the new W-2 formats expected later this year. Training your HR and payroll teams on the new rules is also essential. And keep an eye out for official IRS guidance, which is expected to be finalized later in 2025.

Our Recommendation: Payroll Software That’s Already 2025-Ready

At Ruble Leadbetter & Associates, we rely on Gusto Payroll for our clients—and the good news is they’ve already confirmed compliance updates for the 2025 tax changes.

Gusto automatically tracks and separates tip income, calculates the overtime premium, and updates W-2 forms accordingly. It’s user-friendly, CPA-approved, and ideal for small businesses looking to stay ahead of tax law changes.