OBBBA’s Not-So-Beautiful Overtime and Tip Reporting Requirements

The 2025 federal budget law “One Big Beautiful Bill Act” (OBBBA) created two temporary federal income tax deductions that rely on employer information reporting: (i) a deduction for qualified tips (IRC §224) and (ii) a deduction for qualified overtime compensation (IRC §225). Both apply to taxable years beginning after December 31, 2024, and each terminates for taxable years beginning after December 31, 2028.

Now that 2026 is here and transition relief has ended, it’s time to get into compliance.

Overtime Reporting:

The OBBBA allows a limited deduction for overtime pay earned for hours worked beyond 40 in a workweek, capped at $12,500 (and $25,000 for married employees filing jointly).

Beginning in 2026, employers are now required to separately report “qualified overtime” on Form W-2. Check out the new form here!

The interesting twist for California employers? Not all overtime pay qualifies. Only “FLSA-required” overtime pay should be included in this calculation – i.e., only premium pay for hours worked after 40 per week.

Section 225(c)(1) of the OBBBA defines “qualified overtime compensation” as overtime compensation paid to an individual required under 29 U.S.C. sec. 207 that is in excess of the regular rate at which the individual is employed. In other words, the definition only includes the premium portion of the overtime pay, not the straight-time component (i.e., the “half” portion of “time-and-a-half”).

Tip Reporting:

The OBBBA also requires employers to report cash tips totals and Treasury tipped occupation code(s) on Form W-2.

The statute allows an individual deduction of up to $25,000 equal to qualified tips received during the year that are included in specified information statements (including W-2) and reported on Form 4137.

The statute defines “qualified tips” as cash tips received in an occupation that customarily and regularly received tips on or before December 31, 2024, subject to several conditions – including a specified service trade or business (SSTB) carveout. “Cash tips” expressly include charged tips and tips from tip-sharing arrangements. To qualify, tips must be voluntary and not subject to negotiation. Mandatory service charges do not qualify.

Compliance Procedures:

While the OBBBA has already gone into effect, this past year was a transition period, and the IRS provided penalty relief for failures to include the new separate accountings for qualified overtime and tips in 2025. However, the IRS has now directed employers to use the updated Form W-4 and Pub. 15-T methods so employees can account for expected deductions in withholding during the year.

When filling out the new W-2, employers will see new boxes:

• Box 12, code TP: “Total amount of cash tips reported to the employer” (to support the qualified tips deduction).

• Box 12, code TT: “Total amount of qualified overtime compensation.” The instructions specifically illustrate that only the “half” portion of time-and-a-half is reportable as qualified overtime.

• New Box 14b: “Treasury Tipped Occupation Code(s)” required when reporting cash tips using code TP; up to two occupation codes may be reported, and if any tips were received in a nonqualifying occupation, “000” must be one of the codes.

The IRS also published the Treasury tipped occupation code (TTOC) list on its website, mapping specific occupations to three-digit codes.

The Overtime reporting requirement will be particularly difficult for California employers because only certain overtime payments count. At a minimum, employers will need to implement several processes to comply with the law:

1. To the extent not already utilized, a workweek-based overtime setting that prevents pay period averaging. This must compute FLSA overtime and regular rate by workweek and handle the “no averaging” constraint.

2. A “TT” accumulator that stores premium-only qualified overtime and explicitly excludes:

   1. State-only premiums that are not required under FLSA section 7, and

   2. Overtime paid to FLSA-ineligible populations.

3. A Tip classification layer that distinguishes:

   1. Voluntary cash/charged tips and tip-sharing amounts (potentially qualified); from

   2. Mandatory service charges/automatic gratuities (not qualified tips for federal deduction purposes), while preserving state wage-hour compliance treatment.

4. TTOC occupation mapping and validation:

   1. Store up to two occupation codes per employee for W-2 Box 14b reporting and enforce the “000” rule when any tips arise from nonqualifying occupations.

5. W-2 output mapping:

   1. Support Box 12 TP, Box 12 TT, and Box 14b per IRS 2026 instructions, plus internal reconciliation reports for audit readiness.

6. Employee withholding enablement:

   1. Support intake of updated Form W-4 values and apply IRS withholding methods so employees can account for expected qualified tips/overtime deductions in federal withholding (if they choose).

Employers that delay implementation risk increased payroll errors, compliance costs and wage-hour exposure, so start planning now for your business’s 2026 tax reporting.