H.R.1, the One Big Beautiful Bill Act (the Act), includes several changes that impact payroll, employment taxes, and employee benefits. Below, we answer frequently asked questions about changes in the tax treatment of overtime and tips made by the Act.
Overtime
Q: Why is overtime still being taxed?
A: The Act includes a federal income tax deduction for “qualified overtime,” effective for tax years 2025 through 2028. The Act didn’t specifically create an exclusion from federal tax withholding, which is why overtime is still being taxed. Employees can claim the deduction on their individual federal tax return. Beginning January 1, 2026, employees are able to update their Federal Form W-4 to account for expected qualified overtime deductions. Employees use Worksheet 4(b) of the form to calculate the appropriate deduction amount to place on line 4(b) of the actual W-4.
Generally, employees use prior year deduction totals to help them fill out Worksheet 4(b). Employees who want to decrease their withholdings would do so based upon earnings and taxation in the prior tax year. In the case of deductions for qualified overtime and qualified tip amounts, it is a little trickier due to the fact that the deductions were introduced in 2025 and employees may not have their full deduction amount calculated yet. If an employee wants to submit an updated Form W-4 to account for the deductions prior to filing their 2025 tax return, employees may want to turn to information provided to them by employers showing 2025 amounts for qualified overtime and qualified tips.
The IRS recently provided guidance (IRS Notice 2025-62) granting penalty relief to employers and further affirming that they are not obligated to provide employees with specific accounting of qualified overtime and qualified tip amounts, however the IRS strongly encouraged employers to provide employees with an approximate accounting of these amounts to help employees claim deductions in 2025. The IRS also recently issued guidance (IRS Notice 2025-69) related to how employees can use the information provided by employers to claim the deduction for qualified overtime and qualified tips. This information can also likely be leveraged to assist employees in preparing Worksheet 4(b).
In all cases, individuals may want to consult a tax advisor for further guidance on how to prepare their Form W-4.
Q: Is all overtime considered “qualified” for purposes of the federal tax deduction?
A: No. Under the Act, to meet the definition of “qualified overtime" for the federal tax deduction, the overtime pay must meet the following criteria:
- The overtime pay must be required under Section 7 of the federal Fair Labor Standards Act (FLSA). Overtime not required by the FLSA (such as potentially more generous overtime required under state laws, a collective bargaining agreement or paid voluntarily by employers) isn’t eligible to be deducted; and
- Only the overtime premium portion of the overtime pay required by the FLSA qualifies for the deduction. For example, if an individual is paid $10 per hour for non-overtime earnings, and $15 per hour for overtime, only the $5 per hour premium pay for overtime is eligible for the tax deduction. In this example, the other $10 of each overtime hour paid isn’t eligible for the deduction.
Q: Do you have a sample communication I can provide to employees for the tax year 2025?
A: Yes. ADP has created a sample communication template. You can find it here. Please keep in mind that the template might not be suitable for all circumstances. You may need to modify it to suit your circumstances. You should consult with legal counsel and/or a professional tax advisor for advice as needed prior to using the template.
Q: If I pay overtime in more circumstances than required by the FLSA, such as after 8 hours of work in a day as required by state law or a collective bargaining agreement, is the overtime premium portion earned by an employee for that daily overtime also eligible for deduction?
A: No, as mentioned above, the overtime pay must be required under Section 7 of the federal FLSA to qualify for the deduction. Overtime not required by the FLSA (such as potentially more generous overtime required under state laws, a collective bargaining agreement or paid voluntarily by employers) isn’t eligible to be deducted. Overtime pay after 8 hours of work in a day isn’t required by Section 7 of the FLSA.
Q: How does the overtime deduction phase out for higher-income individuals?
A: The overtime deduction phases out beginning when an individual's modified adjusted gross income (MAGI) exceeds $150,000 for the year (or $300,000, for married filing jointly).
Q: Are there examples demonstrating how individuals can claim the deduction for the tax year 2025?
A: The Department of the Treasury and the Internal Revenue Service have issued guidance that includes several examples.
Tips
Q: Why are tips still being taxed?
A: The Act also includes a federal income tax deduction for “qualified tips,” effective for tax years 2025 through 2028. Like with qualified overtime, the Act didn’t specifically create an exclusion from federal tax withholding, which is why tips are still taxed. Employees can claim the deduction on their individual federal tax return. Beginning January 1, 2026, employees are able to update their Federal Form W-4 to account for expected qualified tips deduction. Employees use Worksheet 4(b) of the form to calculate the appropriate deduction amount to place on line 4(b) of the actual W-4. As stated above, employees may want to refer to information detailing their 2025 qualified tip amounts to assist in preparing Worksheet 4(b). Employees can also refer to IRS Notice 2025-69 for further guidance on how to calculate their 2025 qualified tip amounts.
In all cases, individuals may want to consult a tax advisor for further guidance on how to prepare their Form W-4.
Q: Are all tips considered “qualified?”
A: No. Under the Act, to be considered “qualified tips,” the tips must be cash tips received by an individual in an occupation that customarily and regularly received tips on or before December 31, 2024.
Q: What occupations customarily and regularly received tips on or before December 31, 2024?
A: The Department of the Treasury and the Internal Revenue Service have proposed regulations that identify occupations that customarily and regularly receive tips and define “qualified tips” that eligible individuals may claim as a deduction. The proposed regulations list nearly 70 separate occupations of tipped workers.
Q: Do you have a sample communication I can provide to employees for the tax year 2025?
A: Yes, ADP has created a sample communication template. You can find it here. Please keep in mind that the template might not be suitable for all circumstances. You may need to modify it to suit your circumstances. You should consult with legal counsel and/or a professional tax advisor for advice as needed prior to using the template.
Q: Do tips received by credit card qualify for the deduction?
A: "Cash tips" for purposes of the Act include tips received from customers that are paid in cash or charged and, in the case of an employee, tips received under any tip-sharing arrangement.
The amount must be paid and determined voluntarily by the payor without any consequence in the event of nonpayment and cannot be the subject of negotiation. This would exclude, for example, mandatory service charges and mandatory gratuities (such as those a restaurant imposes on large parties).
Q: Are there examples demonstrating how individuals can claim the deduction for the tax year 2025?
A: The Department of the Treasury and the Internal Revenue Service have issued guidance that includes several examples.
Conclusion
Employers with employees earning qualified overtime or qualified tips should communicate with employees about the changes. Employers should also watch for more information and updates as it is released in ADP’s H.R.1 Resource Center. ADP is closely monitoring developments and will provide updates as more details emerge.
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