The sweeping budget reconciliation law known as the One Big Beautiful Bill Act (OBBBA) includes numerous provisions affecting employers and their workers. The new tax treatment of tips and overtime have grabbed much of the attention, but changes to employer tax credits — some of them potentially lucrative — also deserve your attention.
Tips and Overtime
Although President Trump pledged during his campaign to eliminate taxes on tips and overtime, the OBBBA does not actually go that far. For starters, the relaxed tax treatment is temporary, for the tax years 2025-2028 only. In addition, both tips and overtime earnings are still subject to federal and state payroll taxes, and, in the absence of guidance from the IRS, remain subject to normal income tax withholding requirements.
When it comes to federal income taxes, taxpayers can deduct up to $25,000 of qualified tips on their respective income tax returns. The deduction is available to both employees and independent contractors, regardless of whether they itemize their deductions. However, the deduction begins to phase out when a taxpayer’s modified adjusted gross income (MAGI) exceeds $150,000 (or $300,000 for joint filers).
Among other limitations, the OBBBA states that the deduction is limited to cash tips received by workers in occupations that “customarily and regularly” received tips on or before Dec. 31, 2024. The Treasury Secretary is expected to soon issue guidance on the specific industries in which workers are eligible for the deduction. Qualified tips also must be given “voluntarily,” so it remains to be seen if, for example, restaurant-imposed service charges are deductible.
The OBBBA provides that qualified overtime pay is deductible up to $12,500 (or $25,000 for joint filers). This deduction also is subject to a MAGI-based phaseout, beginning at $150,000 (or $300,000 for joint filers). Notably, the law defines “qualified overtime pay” as overtime compensation paid required to be paid under the Fair Labor Standards Act that “is in excess of the regular rate” paid the employee. In other words, it is not the full “time-and-a-half” that is deductible — a taxpayer can deduct only the extra “half” of pay. This definition also means that overtime pay required by state law, but not by federal law, does not receive preferential treatment. For instance, if an employee working 40 hours per week is paid overtime under state law for hours worked over 8 in a single day, that overtime pay would not be eligible.
Employers are required to report both qualified tips and qualified overtime on employees’ W-2 forms and to submit additional information returns, for which forthcoming IRS guidance is anticipated. Under transition rules, any tips or overtime that must be reported before Jan. 1, 2026, can be estimated using a reasonable method to be specified by the Treasury Secretary. This is another area that will require guidance.
Note: The OBBBA also extends the FICA Tip Credit, for the employer share of Social Security and Medicare taxes, to beauty services — specifically, hair and nail care, esthetics, and body and spa treatments.
Expanded Employer Tax Credits
The OBBBA does more for employers than just add to their reporting requirements. It also enhances some employer tax credits.
For example, beginning in 2026, the new law permanently boosts the maximum employer-provided childcare credit from 25% of qualified expenses to 40% , up to $500,000. Small businesses can claim a credit for 50% of qualified expenses, up to $600,000. The percentage and maximum credit amounts will be adjusted annually for inflation after 2026.
The OBBBA also makes the employer credit for paid family and medical leave permanent after 2025. In addition, it will then allow employers to claim the credit for a portion of premiums for paid family and medical leave insurance, and employees can count toward the credit after only six months of employment. The exclusion for employer payments of student loans is now permanent, too, and the maximum exclusion (currently $5,250) will be adjusted for inflation beginning in 2027.
The budget law enhances the benefit for employer-sponsored dependent care assistance plans, as well. Beginning in 2026, up to $7,500 of an employee’s contributions to an employer-sponsored plan ($3,750 if married filing separately) can be excluded from the employee’s gross income.
The news is not all good for employers on the tax credit front, though. Employers that filed a claim for the COVID-era Employee Retention Tax Credit (ERTC) after Jan. 31, 2024, may not receive a refund. The law prohibits the IRS from issuing refunds if these claims were filed for:
- Wages paid after June 30, 2021, and before Oct. 1, 2021; or
- For a qualified recovery startup business, wages paid after June 30, 2021, and before Jan. 1, 2022.
The OBBBA extends the statute of limitations for IRS audits of these claims, generally to six years from when the claim was filed. It also imposes a 20% penalty for erroneous ERTC refunds.
Make the Most of the OBBBA
The provisions above are only the tip of the iceberg as far as OBBBA provisions affecting businesses. We can help you leverage the changes to minimize your tax bills.
For more information, please contact Michael Loesevitz at [email protected] or your ORBA advisor at 312.670.7444. Sign up here to receive our blogs, newsletters and Client Alerts.
Related Services
Related Industries
Dental
Health Care
Law Firms and Lawyers
Manufacturing and Distribution
Not-For-Profit
Real Estate
Restaurant
Sports & Entertainment
