Understanding the No Tax on Tips and Overtime Provisions in the OBBB: Implications for HR and Employees

On July 4, 2025, President Trump signed the Omnibus Budget and Benefits Bill (OBBB), also known as the One Big Beautiful Bill, into law. This comprehensive legislation introduces significant tax reforms, including provisions exempting certain tips and overtime pay from federal income taxes through targeted deductions.

As an HR professional, understanding these changes is crucial for compliance, payroll management, and supporting your workforce.

Below are the key aspects and their impacts from both HR administrators' and employees' perspectives.

No Tax on Tips Provision

The OBBB allows employees to deduct up to $25,000 in qualified tips from their taxable income for tax years beginning after December 31, 2024 (effective for 2025 earnings). Qualified tips include cash and charged tips in customary tipped occupations, such as hospitality and beauty services, but exclude those from negotiated or non-voluntary sources. The deduction phases out for individuals with modified adjusted gross income (MAGI) exceeding $150,000 ($300,000 for joint filers), reducing by $100 for every $1,000 over the threshold.

For Employees: This represents a boon for service workers, potentially increasing net take-home pay by 10-37% on eligible tips, depending on tax brackets. However, Social Security and Medicare (FICA) taxes still apply, preserving retirement benefits. For 2025, employees will claim the deduction when filing 2026 returns, meaning refunds rather than immediate paycheck boosts. This could enhance job satisfaction in tipped industries but requires careful record-keeping to substantiate claims.

For HR Administrators: Employers must now separately track and report qualified tips on W-2 forms and other returns starting in 2025, using reasonable approximation methods for the first year if needed. Payroll systems will need updates to comply with Treasury guidance, expected within 90 days of enactment. Withholding adjustments won't occur until 2026, so continue standard federal income tax withholding on tips for now. HR teams should educate employees on eligibility, prevent reclassification abuses, and prepare for potential IRS audits, ensuring robust documentation to avoid penalties.

No Tax on Overtime Provision

Similarly, the bill provides a deduction of up to $12,500 ($25,000 for joint filers) on qualified overtime pay—earnings exceeding the regular rate under the Fair Labor Standards Act—for the same tax years, with identical MAGI phaseouts.

For Employees: Overtime workers, common in manufacturing, healthcare, and retail, gain financial incentives to take extra shifts, with tax savings boosting disposable income. Like tips, FICA taxes remain, and the 2025 benefit comes via tax refunds. This could improve employee engagement and retention, especially for hourly staff facing economic pressures, but higher earners may see limited relief due to phaseouts.

For HR Administrators: Track and report qualified overtime separately on W-2s, integrating this into payroll software. No withholding changes in 2025 mean business as usual initially, but anticipate 2026 modifications. Compliance risks include misclassifying pay, so review overtime policies. HR should communicate these perks in recruitment and benefits discussions to foster loyalty, while monitoring for state tax alignments, as the OBBB doesn't preempt local laws.

In summary, these provisions, set to sunset after 2028, aim to reward hard work but demand proactive HR adaptations. Consult legal counsel for tailored implementation, as regulations evolve.