When the One Big Beautiful Bill Act (OBBBA) was signed into law in 2025, it made headlines fast: “No Tax on Tips!” “No Tax on Overtime!” Employees started asking questions. Business owners started Googling. And a lot of confusion followed.
Here’s the truth: the law didn’t eliminate taxes on tips and overtime. What it did was create new federal tax deductions for qualifying workers — and that difference matters a lot for how you run your payroll.
So What Actually Changed?
For tipped employees:Workers in traditionally tipped occupations — think restaurant servers, bartenders, salon workers, personal trainers, and gig economy workers — can now deduct qualified tip income from their federal taxable income. The deduction is capped at $25,000 per year and phases out for individuals earning over $150,000 (or $300,000 for joint filers). These deductions are available for tax years 2025 through 2028.
For overtime workers: Only the “premium” portion of overtime qualifies — that’s the extra 0.5x in time-and-a-half pay. So, if someone earns $20/hr normally and $30/hr for overtime, only the $10 premium is eligible. The deduction maxes out at $12,500 per year ($25,000 for joint filers), again phasing out above $150,000 in income.
Reminder, this only applies to Federal OT rules and not CA rules; meaning only OT that is over 40 hours worked in a week, not the CA over 8 hours daily rule. You will need to track these separately.
And FICA taxes still apply to both. Social Security and Medicare taxes are unchanged by this law.
What This Means for California Businesses Specifically
California adds its own layer of complexity. Unlike many other states, California doesn’t allow a tip credit — employers here must pay the full minimum wage ($16.50/hour in 2026 for most employers) before tips. That means California tipped workers often earn higher base wages than workers in other states, which can push some of your employees closer to the income phase-out thresholds. It also means your payroll system needs to handle both federal deduction tracking and California’s separate state tax rules, which do not conform to the federal deductions.
What You Need to Do as an Employer
This law creates real administrative obligations for business owners:
- Update your W-2 reporting. For 2026, qualified tips must be reported in Box 12 using the new IRS code “TP,” and a tipped occupation code is required in Box 14b. Qualified overtime must also be separately identified on employee W-2s.
- Communicate with your employees. Many workers don’t realize they need to file an updated W-4 to reduce withholding during the year — otherwise they’ll wait until tax return time to see the benefit. Point them to the IRS W-4 instructions and the updated Deductions Worksheet on Line 4(b).
- Audit your payroll system. Your software needs to separately track the Federal overtime premium (0.5x) from the base overtime rate — they can’t be lumped together anymore.
- Set realistic expectations. Research shows tipped workers see average savings of around $392 per year, and overtime workers around $118. Real benefits — but not a windfall. Employees who are expecting huge changes to their paychecks need clear, accurate information from you.
Don’t Let Compliance Slip Through the Cracks
Between new W-2 codes, updated withholding tables, California-specific wage rules, and employee questions landing in your inbox, this is a lot to manage on top of actually running your business. And getting it wrong isn’t just an inconvenience — it can mean IRS penalties and employees missing out on deductions they’re legally entitled to.
Let 3G’s Handle It For You
At 3G’s, payroll compliance is what we do — and we’ve been doing it since 1976. Whether it’s navigating new federal tax laws, updating your W-2 reporting, or answering the questions your employees are bringing to you right now, our team is here so you don’t have to figure it out alone.
Ready to get ahead of it? Visit us at 3-gs.com to get in touch with our team today.
