Known as the One Big, Beautiful Bill Act, H.R. 1 brought numerous federal law changes, mainly to federal tax law, when it was signed on July 4, 2025. Among the wide variety of issues addressed, H.R. 1 creates new tax deductions related to tips and overtime that garnered significant media attention.
In preparation for 2026, here’s a quick look at the new deductions along with related Internal Revenue Service (IRS) updates and guidance as well as employer compliance considerations.
Tax Deduction for Qualified Tips
For the 2025 through 2028 tax years, H.R. 1 creates a new above-the-line deduction for “qualified tips,” under which employees may deduct qualified tips received in certain occupations that “customarily and regularly received tips on or before December 31, 2024,” as identified by the IRS.
Qualified tips are defined as voluntary tips received from customers or through tip sharing without any consequence in the event of nonpayment. They also are not subject to negotiation and are determined by the person paying the tip.
On September 19, 2025, the IRS published a list of occupations that customarily and regularly receive tips, identifying nearly 70 occupations in the following categories:
- Beverage and Food Service
- Entertainment and Events
- Hospitality and Guest Services
- Home Services
- Personal Services
- Personal Appearance and Wellness
- Recreation and Instruction
- Transportation and Delivery
For more details on the specific occupations, employers can review the proposed regulations on the topic.
The maximum total deduction for qualified tips is $25,000. This maximum deduction begins to phase out for individuals whose modified adjusted gross income exceeds $150,000 ($300,000 for joint filers).
Tax Deduction for Qualified Overtime
Also through tax year 2028, H.R. 1 creates a new above-the-line tax deduction for qualified overtime compensation up to $12,500 ($25,000 for joint filers), which, like the deduction of tips, begins to phase out for individuals whose modified adjusted gross income exceeds $150,000 ($300,000 for joint filers).
This deduction applies only to overtime paid under the federal Fair Labor Standards Act (FLSA). The FLSA generally requires that an employee be paid overtime at a rate of 1.5 times their “regular rate of pay” for all hours worked beyond 40 in a workweek. California, of course, has additional overtime rules, generally requiring employers to pay overtime for all hours worked beyond eight in a single workday.
California employers should note that since this deduction applies only to FLSA overtime, daily overtime paid under California law will not qualify for the deduction. California employers should review their payroll systems or consult with their payroll companies and legal counsel on how to track and report FLSA-qualified overtime pay.
Reporting Qualified Tips, Overtime
On August 7, 2025, the IRS announced that certain information returns or withholding tables for Tax Year 2025 (TY 2025) would not have changes. According to the IRS:
- Form W-2, existing Form 1099, Form 941 and other payroll return forms will remain unchanged for TY 2025.
- Federal income tax withholding tables will not be updated for H.R. 1 provisions for TY 2025.
- Employers and payroll providers should continue using current procedures for reporting and withholding.
This means that current tax-related forms do not have separate boxes for reporting qualified tips and overtime compensation. The IRS is, however, working on updated forms for TY 2026. The IRS recently published a draft Form W-2 for 2026 which includes new boxes for recording employees’ qualified tips and overtime. While not final, it gives businesses an idea of how the IRS will address H.R. 1’s changes in 2026.
Recognizing that employers may not have the information required to be reported under H.R. 1, or the systems or procedures in place to correctly file the additional information, on November 5, 2025, the IRS announced that TY 2025 will be treated as a “transition period for IRS enforcement and administration of the new information reporting requirements for cash tips and qualified overtime compensation” under H.R. 1. As such, the IRS is providing penalty relief to employers and other payors for TY 2025 regarding the new information reporting requirements.
Employers should review all IRS guidance regarding H.R. 1 and consult with their tax professional or legal counsel to help ensure compliance with the new tax rules.
Employer Benefits
Finally, H.R. 1 made tax-related changes to certain employer benefit offerings. For example, the law made permanent a tax credit for businesses that choose to provide paid family and medical leave. It also increased the tax credit for employers that provide childcare to their employees, and also increased the exclusion of employer paid education assistance (e.g., tuition, student loans, etc.).
Employers should consult their tax professional or legal counsel on how to take advantage of these tax changes.
James W. Ward, J.D., Employment Law Subject Matter Expert/Legal Writer and Editor, CalChamber
CalChamber members can read more about Tips and Gratuities in the HR Library. Not a member? See how CalChamber can help you.
