Have you been curious about how these significant changes in tax laws would impact your company with a lot of discussion about “no tax on tips” and “no tax on overtime”? With new legislation, which President Trump has supported and which has been named the “One Big Beautiful Bill Act”, employers are expecting larger paychecks.
However, the no tax assurance is by no means a simple directive for employers to cease all withholdings. It adds compliance duties and additional levels of complexity. This employer guide gives you a quick, practical explanation of how these big changes will affect your payroll, reporting requirements, and help your company adjust to this changing tax environment.
No Tax on Tips and Overtime: The Employer’s Perspective
The new provisions create additional individual income tax deductions for qualified tips and qualified overtime compensation, and they go into effect for the 2025-2028 tax years. The main difference is that it is not a direct exemption from withholding at the employer level, but rather a deduction for the employee on their tax return.
No Tax on Tips: Eligible employees in customarily tipped occupations can now deduct up to $25,000 in qualified tip income from their federal taxable income.
No Tax on Overtime: Employees receiving FLSA-required overtime pay can deduct up to $12,500 (or $25,000 for married couples filing jointly) in qualified overtime compensation from their federal taxable income.
Implications for Employers
Your immediate tax on overtime and tax on tips withholding requirements for federal income tax normally remain essentially constant for 2025, even though your employees might benefit when they submit their taxes. Workers can modify their W-4 forms to reflect these additional deductions, which would affect their withholding. Nonetheless, it is the employee’s responsibility to claim the deduction on their yearly tax return.
The Role of OASDI Tax: Social Security & Medicare
The fact that these new deductions DO NOT remove the need to pay the OASDI tax (Social Security and Medicare taxes) is one of the most important things for employers to understand.
Social Security Tax: Up to the yearly pay base limit, the Social Security tax (6.2% employer + 6.2% employee) is still applied to all wages, including overtime and tips.
Medicare Tax: There is no wage base limit for the Medicare tax (1.45% employer + 1.45% employee), which is still applied to all wages, including overtime and tips. For high earners, there may be an additional 0.9% Medicare tax.
This implies that you, as the employer, must still withhold and return the employer and employee portions of OASDI tax on all reportable gratuities and overtime wages, even if your employees’ federal income tax is essentially decreased as a result of these new deductions. Neglecting to do so may result in severe consequences.
Phantom Tax for Employers
Phantom tax is frequently used to describe a tax obligation resulting from income that has not yet been paid in cash. Although usually linked to investment profits or non-cash pay, a phantom tax for employers may result from a misinterpretation or poor implementation of the regulations under these new tax laws.
Misinterpretation of “No Tax”: Employers will incur a sizable obligation if they erroneously think they are exempt from withholding any taxes, including FICA, on tips or overtime. The term “no tax” does not mean that the employer is completely exempt from paying any taxes at the payroll level; rather, it refers to the employee’s federal income tax deduction.
Compliance Complexity: Even if withholding isn’t directly impacted, the requirement to identify and record qualified tips and overtime separately on W-2s adds another level of administrative difficulty. Employers need to make sure that these precise quantities can be tracked and reported by their payroll systems.
Risk of Reclassification Abuse: The law contains clauses designed to “prevent abuse” and income reclassification. Employers risk harsh fines and audits if they try to classify regular pay as “tips” or “overtime,” only to take advantage of these deductions (and maybe lower their own FICA burden if not correctly understood). Vigilance is required in this critical area to prevent a “phantom” liability.
Key Employer Steps and Compliance Measures
The following actions should be taken right away by employers to successfully manage these new tax provisions:
Stay Informed: Tax laws are subject to change. For clarifications, new rules, and any other legislative changes, keep an eye on credible tax advisories and official IRS guidance, particularly as the 2025 tax year goes on.
Review Payroll Systems: As needed beginning in 2026 (with a transition regulation for 2025), make sure your payroll software and procedures can monitor and report “qualified tips” and “qualified overtime compensation” separately on Form W-2.
Communicate with Employees: Inform your staff members about the new deductions. Describe how they would claim the deduction on their personal income tax returns, even if their take-home pay may not show the “no tax” benefit right away.
Understand Reporting Requirements: Despite the new deductions, you must continue to record tips to the IRS (e.g., on Form 941), and employees must continue to report tips to you totaling more than $20 per month.
Ensure OASDI Obligations: Internally reiterate that all tips and overtime wages are still subject to Social Security and Medicare taxes (OASDI). Make sure that these are computed, withheld, and sent in the right way.
Consult with Tax Professionals: To guarantee complete compliance and streamline your payroll procedures, it is strongly advised that you speak with a certified payroll or tax professional due to the subtleties and possibility of misunderstanding.
Understand New Tax Realities and Stay Compliant!
It can be difficult to comply with the new tax requirements pertaining to overtime and tips, but you don’t have to do it alone. Expert attention is required due to the intricacies of “no tax” deductions, continuing OASDI obligations, and ensuring accurate reporting. Our specialty at Koffex Accounting is providing small and midsize companies like yours with smart, transparent, and legal financial solutions. For peace of mind and optimal financial health, work with us and avoid letting new regulations turn into a “phantom tax” pain. We can make sure your payroll complies with all current regulations!
FAQs
What does “No Tax on Tips” and “No Tax on Overtime” actually mean for my business’s payroll?
While new legislation (like the “One Big Beautiful Bill Act”) aims to provide federal income tax relief on tips and overtime for employees, it’s primarily an individual income tax deduction that employees claim on their tax returns. Employees might adjust their W-4s, but you’re still responsible for reporting and withholding.
Will I no longer have to pay OASDI tax on tips and overtime?
No, this is a misunderstanding. The new “no tax” provisions do not affect OASDI tax (Social Security and Medicare taxes). As an employer, you are still fully responsible for withholding the employee’s share and paying your matching employer share of OASDI tax on all eligible tips.
How do these changes impact how I report tips and overtime on W-2 forms?
Even with the new deductions, all tips received by employees (if $20 or more per month) must still be reported to you, and you must report these amounts on Form W-2.