Payroll Brass Tax: Changes in Tip and Overtime Taxation

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Stephen Kenney: Hello, and welcome to the latest episode of Payroll Brass Tax. This is your host, Stephen Kenney, and I am a payroll tax attorney in the Ogletree Deakins Dallas office.
Today, I am joined by Victoria Vish. Victoria is a shareholder in our Dallas office, she represents employers on all day-to-day employment matters. She provides counsel and advice pertaining to employee separations, disability accommodation requests, wage and hour issues, and implementing sound employment policies. She’s a key leader in our wage and hour practice group. She also has particularly extensive knowledge on laws and regulations related to the use of the tip credit, tip sharing, tip pooling, and automatic service charges. Naturally, she serves a lot of clients in the hospitality industry.
She’s joining me today to talk about the recent legislation known as the One Big Beautiful Bill that was signed into law on July 4th by President Donald Trump. In particular, we will discuss the no tax on tips and no tax on overtime provisions. Victoria, thank you for joining me and welcome to the podcast.

Victoria Vish: Well, thanks for having me, Stephen. And you forgot to mention that we’re in the same office, but we’re also next-door neighbors. So, anytime I have a tax-related question for a client, I just conveniently pop into your office.

Stephen Kenney: Exactly. You are my favorite neighbor, don’t tell my other neighbor.

Victoria Vish: Love to hear that. Yeah, I really appreciate the opportunity to talk to you today on the podcast and gather some information that I’ve already been asked by clients on this One Big Beautiful Bill that was signed into law so recently. So, I’d love to ask you some questions, get your insight, and best predictions you have, until we get more guidance from the IRS. So, just let me know when you’re ready.

Stephen Kenney: I am ready. Let’s do it.

Victoria Vish: Okay. So, the One Big Beautiful Bill, I’m sure everyone has seen at least one news article, that it was signed by President Trump, went into effect July 4th. So, does this mean that the bill is current, for it’s the 2025 tax year, or is there a different effective date employers need to be aware of?

Stephen Kenney: Yeah, that’s a good question, Victoria. So yeah, it was signed on July 4th, and so some of its provisions go into effect immediately in 2025, and by immediate, I really mean dating back to January 1st of 2025, and some will go into effect in 2026.
The two topics we’re talking about, the no tax on tips and no tax on overtime provisions, go into effect immediately for tax year 2025, so dating back to January 1st of this year, and could potentially be eligible for the tax credit for this year. The individual income tax credit could be taken this year in 2025.

Victoria Vish: Got it. Okay, and for these particular subjects, the deductions, is there an expiration date for when the deductions would end?

Stephen Kenney: Yes. So, the no tax on tips and no tax on overtime are set to expire at the end of 2028, so December 31st, 2028. So, they will no longer be in effect starting in 2029.

Victoria Vish: Great. Okay, and let’s just break down the deductions. Let’s start with the tax deductions on tips. I guess the first question is, does the bill even define tips, and is it consistent with IRS regulations that are currently in effect?

Stephen Kenney: So, the bill doesn’t necessarily define tips, per se. Tips are what they were before; they are what they are after this bill. They’re still voluntary payments not subject to negotiation and determined by the customer, and that is consistent with the current IRS regulations.

Victoria Vish: Yeah, and I think that’s an important distinction, at least in the work that I do with clients from a wage and hour perspective, is sometimes we’ll have companies and businesses that will call an automatic charge on a bill, a gratuity, and they’ll say, “A 20% gratuity is added to your bill.” That would not be subject to this deduction because that is an automatic charge, which is separate and distinct from a voluntary tip paid by a patron. That’s consistent with the bill?

Stephen Kenney: Yeah, no, that’s correct, Victoria. Automatic or mandatory service charges are not eligible for the deduction.

Victoria Vish: Got it. Okay, and does the tax deduction on tips apply to only certain employees, certain industries?

Stephen Kenney: Yes, that’s correct. So, as the bill reads, you must have a qualified tip in order to be eligible for the deduction. And qualified tips are those received by an employee in an occupation which has customarily and regularly received tips on or before December 31st, 2024, AKA, before 2025.

Victoria Vish: And what’s interesting about that is that the regularly and customarily tipped employees is a big component of the regulations and laws that we deal with in tips and service charges, generally. Does the IRS anywhere currently define what those occupations are, or is that something that’s either in the bill or something that we have to wait for the IRS to define later on?

Stephen Kenney: The IRS does not currently define customarily and regularly tipped occupations, but it is instructed to do so. So, the IRS is going to be required to publish a list of occupations that customarily receive tips, not later than 90 days after the date of enactment, so the date of enactment is July 4th. And that list must cover occupations that customarily and regularly receive tips on or before the end of 2024. And then the IRS must also update the withholding procedures related to this deduction, but that doesn’t have to start until 2026.

Victoria Vish: Got it. In wage and hour law, a tipped employee is someone who customarily and regularly receives more than $30 a month in tips, and it’s almost sort of a circular argument in the definition itself. So, it’ll be interesting to see what the IRS comes up with. We’ve had under past administrations, attempts to define what these occupations could be. The type of occupations that come to mind immediately in the restaurant industry are servers and bussers and bartenders, but I think it’ll be quite a task for the IRS to come up with a complete list of occupations or how they might give some wiggle room there, and how it should be defined. So, that’s the tax deductions on tips.
Now, let’s talk about tax deductions on overtime. How is that working under the bill? And that obviously expands to more businesses and more employees who aren’t just receiving tips, but now it’s employees who work overtime. Explain what the benefits will be for employees who work overtime.

Stephen Kenney: Yeah, so the tax deductions on tips and overtime have some similarities. For instance, they are both individual income tax deductions. So, when an individual files his or her individual income tax return based upon his or her W-2 in 2026 by April 15th of 2026 for tax year 2025. That’s really when this deduction comes into play for the individual. Now at that point in time, taxpayers may deduct up to $12,500 in qualified overtime compensation for individual filers, and then $25,000 for joint filers. So that’s a little bit lower than the $25,000 per year per taxpayer that’s allowed for deduction on tips, but they both have the same phase-out requirements. So, the deduction starts to phase out by $100 for every $1,000 of modified adjusted gross income above $150,000 for single filers. That’s both for the overtime deduction and the tip deduction, and that’s $300,000 for joint filers. Now, qualified overtime compensation is defined as overtime pay required under section seven of the FLSA, that is in excess of the regular rate. So only that qualified overtime compensation is going to be available for the overtime deduction.
And lastly, the one thing that both of these deductions have in common is that they’re available to non-itemizers, which means they can be claimed in addition to the standard deduction. The standard deduction has been significantly raised over the years, so a lot of taxpayers take advantage of the standard deduction. Here, even if you are taking the standard deduction, you can still take these deductions for tips and overtime.

Victoria Vish: So, if we are just breaking it down a little bit further, question number one is, if an employer is trying to explain to one of their employees what all this means and they wanted to give kind of just a rough estimate of the benefit that the employee’s receiving for both of these deductions, is there a way that depending on the state or location of the business and the employee, that we can ascertain that?

Stephen Kenney: So, actually, the White House has provided a calculator. So, the employer could direct the employee to go to the White House’s website and work through that calculator. Of course, it’s always a little risky when employers start talking to employees about individual income taxes because the employer doesn’t have all the information in regards to the individual’s income taxes. The employer doesn’t really know all of the income sources, all of the deductions, and what an employee’s spouse may make in terms of income. So, it’s really something that the employer should direct the employee to the IRS, to the White House’s publicly facing website, and that information to really help the employee understand what’s out there for them in terms of these new tax deductions.

Victoria Vish: I guess while maybe an employer isn’t directly the one benefiting from these deductions, what we could say though is that the “savings” that an employee is ultimately getting from these deductions could change an employer’s policy or how they’re paying their employees. If they’re getting this tax break and more money in their pocket, then an employer may want to consider changing the wage rates that they pay employees. Do you see that as being a possibility here?

Stephen Kenney: It’s certainly a potential business decision that an employer might make. So these tax deductions are a direct benefit to employees, but there are certainly some indirect benefits to employers since their employees will be the ones receiving tax relief. I could see employees are more incentivized to put in more hours if they know that the overtime rate that they are now receiving is going to be tax advantaged versus their regular rate. So, it could create some incentives that certainly benefit employers.

Victoria Vish: Yeah, that’s a good point. With the deduction on tips, am I correct in saying that employers still need to be requiring their employees report all tips? And I mean, obviously, there’s only so much an employer can do, but under the law, it’s still required that employees report all tips, and now they’re just incentivized more so to do that because of the deductions?

Stephen Kenney: Yes, that’s correct. All tips need to be reported just as they currently are and just as they currently were before the bill passed. Everything needs to be reported.

Victoria Vish: And with regard to what the bill says about the employers’ reporting obligations on W-2s and other tax forms, what do we anticipate will come of that? I mean, is the IRS going to issue a new form for employers to use? And what changes do we think will come once they’ve issued their guidance?

Stephen Kenney: Yeah, so in order for employees to be able to take advantage of the deduction, they need to have the tip income reported. They need to have the overtime compensation reported in a manner that the IRS can see, so that they can say that the employee is entitled to the deduction. So here, that means both of those components, the tip income and the overtime compensation, are going to have to be reported on the employee’s form, W-2.
Now, how exactly it’s going to be reported, that’s yet to be determined. My expectation is that they are going to have to modify the W-2 a little bit in order to account for this new reporting requirement, specifically for overtime compensation, because that’s not something that every employer tracks as closely as they do tips, since tips have their own reporting requirements, their own pre-existing reporting requirements. So, there is some transition relief in the bill, particularly for overtime compensation. So the reporting entities, AKA the employers, may use reasonable methods to estimate and report qualifying amounts during the transition period. The Treasury secretary is also going to provide guidance on what that means specifically. So, what kind of relief is actually available during the transition period if you’re not quite able to capture all of the overtime compensation.

Victoria Vish: Got it, that’s helpful. I guess we’ll know more in October, and we’ll have to do another podcast at that point.
We talked about the deductions. I want to move on to the FICA tax credit, and the bill touches a little bit on a change in that regard, and where it now includes beauty in the aesthetics industry, whereas before it was just the food and beverage service industry. Before we get into the change, can you just explain in the simplest terms possible, what is the FICA tax credit?

Stephen Kenney: So, this is a credit that allows employers to reduce their business taxable income by the amount they pay for the employer’s share of social security and Medicare taxes, AKA FICA, on employee tips. If we think about social security and Medicare, there’s an employee side that employees are familiar with because it’s a line item on their paychecks, it reduces, it’s a withholding from their income. The employer is also paying a corresponding tax that equals the employee side tax. So, what we’re talking about for this tax credit is just that employer side of the FICA tax, and specifically the employer side of the FICA tax on employee tips.

Victoria Vish: Got it. Okay, and for our clients that are now eligible for this credit, is there anything that they need to do proactively right now to claim it, now that whatever beauty industry or aesthetics industry they may be part of and they haven’t done this before, what steps should they take to claim this credit?

Stephen Kenney: Yeah, so they do need to start reviewing the tips that their employees have already received thus far this year, and then continue to work through that for the remainder of the year. So first, it’s identify the tips on which they paid the FICA tax. And then second, they’re going to need to calculate any tips that aren’t creditable because not every tip is creditable here, because if the employee’s wages excluding tips are less than $5.15 an hour, a portion of those tips aren’t creditable because it’s only the portion that equals the amount that would’ve been payable to the employer at $5.15 an hour, minus the actual wages paid to the employee. So, if you pay somebody less than $5.15 an hour, and $5.15 an hour is the 2007 minimum wage rate, then that difference between what you pay them and $5.15 an hour is not eligible for the FICA tip credit. Once they get tips that exceed that $5.15 an hour, those tips are then eligible for the FICA tip credit, assuming, of course, that you, as the employer, paid the FICA tax on those tips.
So, once you’ve done those first two steps, you’ve got the third step is to determine the creditable tips by subtracting any of the tips that aren’t creditable. And fourth, it’s calculating the credit amount by multiplying the creditable tips by the FICA tax rate. And that’s just the employer side, so the 7.65%, that accounts for the employer side social security and Medicare. Once you’ve done that, and really, this is done on the Form 8846, the credit for employer social security and Medicare taxes paid on certain employee tips, that form walks through these steps. Probably going to be completed by your accounting department or your third-party accountant. And that form is then attached to your business income tax return, which in turn enables you to take the credit on your business income tax return.

Victoria Vish: Got it. And if we have clients that have questions about that, that’s something that we may be able to provide more guidance once, again, the secretary issues their guidance by October.

Stephen Kenney: Yeah, that’s a good point. The bill, as it reads, has only really told us that these are the industries: barbering, hair care, nail care, body and spa treatments, and aesthetics. Those businesses providing those services might now be eligible for the FICA tax credit. We don’t know specifics, in terms of licensing, or really, what is the extent of aesthetics. That might be a term that needs to be further defined by the IRS. So, we are also waiting for guidance on this element of the bill.

Victoria Vish: Got it. And when you were talking about the 2007 $5.15 wage rate, it made me think of one other point we should mention here. Going back to the deductions on overtime, and you mentioned this, that the qualified overtime is pursuant to overtime under section seven of the FLSA. So, you agree then that to the extent there are any state laws that require different overtime premiums and things like that, that’s not what’s going to be covered as a deduction under this bill. Is that accurate?

Stephen Kenney: Yeah, that’s correct. It really is going to come down to the FLSA definition, because that is what is cited specifically within the bill.

Victoria Vish: All right. And so, other than the bill’s expansion of potentially eligible industries into this FICA tax credit, does the bill otherwise affect an employer’s ability to take the tax credit? In other words, it’s not hindering or impeding or otherwise changing the ability to do so, it’s just expanding that ability for other industries?

Stephen Kenney: Yes, that’s correct, Victoria. It’s pretty much just an enhancement. It’s not going to limit any of the restaurant employers that were currently taking advantage of the FICA tax credit. It’s expanding it so that those in the beauty industry can now take advantage of the same tax credit.

Victoria Vish: Okay. Well, that’s a lot of information and a lot of tax terminology, but extremely helpful. And I think we’ll assist our clients in the industries impacted by the bill in taking steps to move forward to comply with the new requirements and potentially saving them some business income on the FICA tax credit side, if they’re able to take that. So, really do appreciate you explaining all this and explaining it in a way that makes sense and isn’t in your tax legal jargon. But I guess we will follow up in October and see what the IRS does with its guidance, and we’ll revisit all of this.

Stephen Kenney: Yes, thank you for the great conversation, Victoria. We are certainly going to be awaiting additional guidance, so the countdown is on to see what employers have to do for year-end events to ensure that these tax deductions are properly accounted for on the employees’ W-2s. And then also, really, which occupations are going to be eligible for the tip deduction?
I really appreciate you joining me today on Payroll Brass Tax, and thank you to everyone for listening. We will be back next month with another installment of Payroll Brass Tax. Stay well.

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