How Will the New Tax Law on Tips and Overtime Pay Affect Employees and Business Owners?

October 3, 2025

President Trump’s “One Big Beautiful Bill Act” introduced federal income tax deductions for employees who earn tips and overtime pay. While the measure is temporary (in effect through 2028), it marks a significant change in how these forms of income are treated and carries important implications for business owners, particularly in traditionally tipped industries like hospitality food service, and personal care.

Employer Responsibilities and Business Impacts

The law introduces both compliance requirements and strategic opportunities for employers:

  1. Payroll and Reporting Adjustments

Employers must ensure, as before, that they are accurately tracking qualified overtime wages and qualified tips. These amounts must be reported on Form W-2, with clear classification of employee occupations. In addition, updates to Form W-4 may be required to reflect the new deductions and withholding rules. Businesses may need to invest in upgraded point-of-sale systems, tip-sharing policies, and payroll administration to ensure compliance.

  1. Employee Compensation Strategies

With the federal tax deduction reducing employees’ income tax burden, employers have the opportunity to enhance take-home pay without increasing labor costs. Strategically managing tips and overtime pay can improve employee satisfaction and help attract and retain talent in competitive industries.

  1. Industry-Specific Impacts

The deduction applies only to voluntary tips in qualifying occupations, requiring careful verification of eligibility. The IRS is expected to provide guidance listing qualifying roles.

  1. Potential Shift in Tipping Practices

Businesses that replaced tipping with service charges may see pressure to maintain traditional tipping structures, as only voluntary tips qualify for the deduction.

  1. Impact on Tip Pools and Worker Equity

In states allowing tip pooling, the deduction benefits a broader range of employees, potentially improving compensation for kitchen staff indirectly. In states with restrictive tip-pooling rules, the benefit may be limited to front-of-house employees, which could influence wage structures and labor relations.

  1. Employer Tax Obligations Remain Unchanged

Employers’ obligations with respect to the withholding of income taxes are unchanged by this law. Likewise, FICA contributions (Social Security and Medicare) must continue to be withheld and paid in the same way as prior to this new law. Employer payroll tax responsibilities are not reduced under the new provision.

Takeaway

This new law makes temporary changes to the federal tax treatment of tips and overtime pay, with direct implication for both employees and employers. Employers must continue to withhold FICA taxes on these amounts and ensure accurate reporting of employee occupations, qualifying tips, and qualifying overtime wages on IRS forms.

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