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Managing Payroll Taxes Under the Recent “Big Beautiful Bill”

By Jacqueline Talbot posted 08-20-2025 09:10 AM

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The One Big Beautiful Bill Act was signed into law on July 4th, 2025. The Act is primarily a tax act and includes extensive provisions that impact employer-sponsored employee benefits and compensation. While impacts of the law cover broad swaths of the economy (many tax exemptions are extended or made permanent and HSA account provisions expanded), a lot of media attention has been placed on tax deductions on qualified overtime and tipped income. This article will focus on how employees can deduct certain amounts of their overtime premium pay and tipped income from their federal income taxes and the related employer reporting responsibilities. Deductions are capped and subject to certain income thresholds. The Act does not eliminate taxes on overtime entirely but rather provides a deduction from taxable income.

Provisions related to Overtime Tax Exemptions are:

Deduction Limit: An employee can deduct up to $12,500 in overtime premium pay per year ($25,000 for married couples filing jointly)

Qualifying Overtime: The deduction applies only to overtime premium pay required under the Fair Labor Standards Act. (FLSA). This means it applies to the overtime for hours worked over 40 hours within the workweek and at the rate of 1.5 times the regular rate. This means overtime pay required by state laws, collective bargaining agreements, or voluntarily paid by employers will generally not qualify.

Premium Portion: Only the premium portion of overtime pay (e.g., the extra 50% for time-and-a-half) is eligible for the deduction.

Example: A regular wage rate is $20.00/hour. When an employee works overtime, the employee is paid $30.00/hour for those hours (1.5 x regular wage rate). The premium portion is the $10.00/hour difference. That is the portion that is eligible for a tax deduction.

Tax Filing: The overtime earnings for all of 2025 will be reported separately on W-2s at the end of the year. This is how the amount of the potential deduction will be determined for tax reporting purposes. The Act requires the IRS to update the applicable income tax withholding procedures and tax forms to reflect this new deduction.

Income Threshold: The deduction begins to phase out for individuals with a modified adjusted gross income (MAGI) exceeding $150,000 ($300,000 for married couples filing jointly). For every additional $1,000 earned above the threshold, the deductible amount is reduced by $100.

Tax Withholding: An employer will still withhold taxes on overtime throughout the year. The deduction is claimed when an employee files a federal income tax return.

FICA Taxes: The bill does not eliminate Social Security and Medicare taxes on overtime.

Temporary Nature: The tax deductions are temporary and are set to expire at the end of 2028, unless extended.

The tax deduction mechanism for tipped employee income is very similar to overtime rules:

Workers in eligible tipped jobs can deduct up to $25,000 of their reported tips from their taxable income.

However, this deduction only applies to federal income tax. State, local, and payroll taxes (Social Security and Medicare) on tips will still be owed.

Individuals earning up to $150,000 annually ($300,000 for joint filers) are eligible.

Specific job eligibility will be further clarified by the U.S. Treasury Department and the IRS, but this information is not yet available. The IRS must publish, by October 2, 2025, a list of occupations that “customarily and regularly” received tips on or before December 31, 2024.

Workers must still report tips to employers, who will continue to withhold federal income tax, Social Security, and Medicare taxes from both wages and tips.

Since most of the overtime and tipped income-related provisions of the Act do not take effect until tax reporting after the end of 2025, there are generally no urgent actions that must be taken at this time. Instead, employers should work with their payroll providers or payroll software before year-end to make sure that their reporting abilities encompass the changes to tax deductions available for overtime and tipped income pay.