The IRS recently announced penalty relief to employers for tax year 2025 for reporting requirements under the One Big Beautiful Bill Act (OBBBA) for qualified overtime compensation and cash tips.
The OBBBA's new "qualified overtime" deduction applies to the 2025 tax year (through taxable year 2028) only for weekly overtime under the Fair Labor Standards Act (FLSA). States including Alaska, California, Colorado, and Nevada, as well as Oregon in certain industries, have daily overtime requirements that exceed federal law. The new deduction requirement means employers will be obligated to set up systems to separate overtime paid under the FLSA from overtime paid for other reasons, according to Nisha Verma, an attorney with Dorsey & Whitney in Costa Mesa, Calif., and Palo Alto, Calif. The law also provides a deduction for qualified tips.
Now the IRS said that for tax year 2025,"employers and other payors will not face penalties for failing to provide a separate accounting of any amounts reasonably designated as cash tips or the occupation of the person receiving such tips," the agency announced Nov. 5. "In addition, employers and other payors will also not face penalties [for tax year 2025] for failing to separately provide the total amount of qualified overtime compensation."
The agency noted that the relief is limited to returns and statements filed and provided for tax year 2025. Significantly, the relief applies "only to the extent that the person required to make the return or statement otherwise files and provides a complete and correct return or statement."
Rationale for Relief
The IRS said it was aware that employers may not have the information required to be reported under the OBBBA, or the systems or procedures in place to be able to correctly file the additional information.
"Moreover, the IRS has announced that Forms W-2 and 1099 for tax year 2025 will not be updated" to account for the law's changes. Tax year 2025 as a result "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."
The IRS nevertheless encouraged employers and other payors to provide employees and payees, particularly those in a tipped occupation, with the occupation codes and separate accountings of cash tips, so the employee can claim the deduction for qualified tips for tax year 2025. Similarly, it encouraged employers to provide employees with separate accountings of overtime pay so an employee has the information needed to claim the deduction for qualified overtime compensation for tax year 2025. Such information can be made available by employers to employees through an online portal, additional written statements or other secure methods, or in the case of qualified overtime compensation, in Box 14 of the employee's Form W-2, the IRS said.
New Reporting Requirements
While penalties are waived for tax year 2025, HR professionals need to understand the OBBBA's reporting requirements to prepare for subsequent tax years. Moreover, the goal of the changes is to enable employees to claim new tax deductions.
Eligible employees may deduct up to $12,500 ($25,000 for joint filers) from their federal taxable income based on the premium portion of their overtime earnings. The premium portion of overtime pay is the extra half-time received for working more than 40 hours in a workweek under the Fair Labor Standards Act. The deduction begins to phase out when an employee's annual modified adjusted gross income (MAGI) exceeds $150,000 (or $300,000 for joint filers).
"Qualified tips" are cash tips received by an individual in an occupation that "customarily and regularly received tips" as of Dec. 31, 2024. Qualified tips are those determined and paid voluntarily without any consequence in the event of nonpayment. Mandatory gratuities and service charges are excluded. Tips eligible for deduction are limited to $25,000 per individual or $50,000 if filing jointly. Similar to the overtime deduction, the tip deduction begins to phase out when an individual's MAGI exceeds $150,000 (or $300,000 for joint filers).
Steps for HR
HR should take steps now to prevent penalties when the relief period ends. Such steps may include:
--Auditing an employer's current payroll and human resource information system (HRIS) capabilities. Can your payroll software or HRIS be configured to track and report the new required data? Ask any vendors about their plans for OBBBA compliance.
--Consider voluntary information sharing. The IRS encourages employers to provide the new information to employees for tax year 2025. Doing so, if feasible, would support employees.
--Educate your workforce. Develop internal communications explaining the OBBBA tax benefits and transition year. Clarify that while the company is working on system updates, employees may need to track their own information for their 2025 tax return. Recommend employees consult with a tax professional and refer to IRS guidance as it becomes available.
The 2025 penalty relief is a temporary measure. Enforcement is expected for tax year 2026. HR can use the transition period to ensure their organization is prepared.
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