The One Big Beautiful Bill Act (OBBBA) introduced new deductions that sound simple on the surface but, in practice, are anything but. As filing seasons approach, confusion around qualifying income, reporting obligations, and eligibility rules continues to grow.
Based on IRS guidance issued at the end of 2025, the following five points highlight the most important rules and risks surrounding the new deductions for tips and overtime. These are the issues driving the most questions and the most mistakes heading into the upcoming filing seasons.
1. Only Overtime Paid Under Federal Labor Law Qualifies
Not all overtime pay qualifies for the new deduction.
To be deductible, overtime must be paid under Section 7 of the Fair Labor Standards Act (FLSA). This generally means:
- Time-and-a-half pay
- For hours worked over 40 in a workweek
- Paid to non-exempt hourly employees
Overtime paid due to:
- State daily overtime laws
- Collective bargaining agreements
- Collective bargaining agreements
- Salaried compensation arrangements
does not qualify, even if it is labeled as overtime on payroll records.
Federal labor law, not payroll terminology, determines eligibility.
2. The Deduction Is Claimed on the Individual Return, Not by the Employer
Another frequent misunderstanding is who actually benefits from the deduction.
The OBBB deductions for qualifying tips and overtime are:
- Claimed by the worker on their personal tax return
- Not deducted by the employer
The employer’s responsibility is limited to tracking and reporting qualifying amounts when required. This distinction is critical when reviewing income that is fully taxable but partially deductible under OBBB rules.
3. 2025 Allows Flexibility, but 2026 Requires Precision
The reporting framework changes significantly between years.
For 2025 returns:
- Employers are not required to separately report qualifying tips or overtime
- W-2 and 1099 forms were not updated for 2025
- IRS Notices allow the use of reasonable methods when data is incomplete
For 2026 returns:
- Separate reporting becomes mandatory
- New W-2 Box 12 codes apply:
- TT for qualifying overtime
- TP for qualifying tips
- Updated Forms 1099-NEC, 1099-MISC, and 1099-K introduce new reporting fields
This creates a transition year in 2025, during which professional judgment is required, followed by rigid reporting standards in 2026.
4. Only the “Premium” Portion of Overtime Is Deductible
Even when overtime qualifies, the full overtime payment is not deductible.
Only the amount paid above the regular hourly rate qualifies.
Example:
- Regular pay: $20/hour
- Overtime pay: $30/hour
- Deductible amount: $10, not $30
If an employer pays double time, the deductible amount does not increase. The deduction is capped at the amount required under FLSA.
5. Tips Must Be Voluntary. Automatic Gratuities Don’t Count.
The new tip deduction is far more limited than many expect.
Qualifying tips must be:
- Voluntary
- Paid in cash or charged to a card
- Properly tracked and reported
The following do not qualify:
- Automatic gratuities
- Mandatory service charges
- Non-cash tips (including goods or cryptocurrency)
Even if a payment is labeled a “tip,” it will not qualify if it is not voluntary.
Learn More: 2026 OBBBA Update With New Guidance
If you want a deeper, step-by-step explanation of these rules, including real-world examples, IRS Notices, and practical preparation guidance, My Tax Courses Online’s 2026 OBBBA Update With New Guidance provides the clarity these changes demand.
This comprehensive course walks through:
- How the OBBB deductions for tips and overtime actually work
- What qualifies, what does not, and why
- How to handle incomplete reporting on 2025 returns
- What changes in 2026 with the new W-2 and information return requirements
- How late-2025 IRS guidance affects real-world preparation decisions
The course is built entirely on IRS guidance issued at the end of 2025 and is designed to help you prepare accurate, defensible returns across both tax years, while avoiding common errors that can lead to missed deductions or compliance issues.
Available now at My Tax Courses Online. Click here.
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