Compliance
Compliance Update: New Rules for Deducting Tips, Overtime, and Backup Withholding under OBBB
The One Big Beautiful Bill has introduced sweeping compliance changes affecting tip and overtime deductions and revised thresholds for backup withholding—businesses and individuals need to adjust now.
By NomadicTax Research Team • 5-8 min read • February 22, 2026
## What’s New in Tip & Overtime Deductions
- For the 2025-2028 tax years, taxpayers who receive **“qualified tips”** may deduct up to **$25,000** ($150,000 MAGI threshold for phaseout, $300,000 for joint filers). ([irs.gov](https://www.irs.gov/newsroom/one-big-beautiful-bill-how-to-take-advantage-of-no-tax-on-tips-and-overtime?utm_source=openai))
- Similarly, **qualified overtime compensation** (the portion of overtime pay required by FLSA above the regular rate) may be deducted up to **$12,500** ($25,000 if married filing jointly). ([irs.gov](https://www.irs.gov/newsroom/treasury-irs-provide-guidance-for-individuals-who-received-tips-or-overtime-during-tax-year-2025?utm_source=openai))
- These deductions are available regardless of whether you itemize or use the standard deduction. ([irs.gov](https://www.irs.gov/newsroom/one-big-beautiful-bill-how-to-take-advantage-of-no-tax-on-tips-and-overtime?utm_source=openai))
- Employers are required to separately report these amounts starting in **tax year 2026**, but 2025 has transition relief—employees can use employer statements, pay stubs, or logs. ([irs.gov](https://www.irs.gov/newsroom/questions-and-answers-about-the-new-deduction-for-qualified-overtime-compensation?utm_source=openai))
## Backup Withholding & Reporting Threshold Changes
- Proposed regulations were issued (IR-2026-03) to revise thresholds for when **third-party settlement organizations (TPSOs)** must perform backup withholding on payments made through platforms. ([irs.gov](https://www.irs.gov/newsroom/treasury-irs-issue-proposed-regulations-reflecting-changes-from-the-one-big-beautiful-bill-to-the-threshold-for-backup-withholding-on-certain-payments-made-through-third-parties?utm_source=openai))
- Under the new proposed threshold, backup withholding applies only when **both** the total payments exceed **$20,000** and the number of transactions exceeds **200**. This replaces earlier lower thresholds. ([irs.gov](https://www.irs.gov/newsroom/treasury-irs-issue-proposed-regulations-reflecting-changes-from-the-one-big-beautiful-bill-to-the-threshold-for-backup-withholding-on-certain-payments-made-through-third-parties?utm_source=openai))
- The regulations also reflect changes made by OBBB that restored the pre-American Rescue Plan Act of 2021 thresholds for Form 1099-K reporting. ([irs.gov](https://www.irs.gov/newsroom/treasury-irs-issue-proposed-regulations-reflecting-changes-from-the-one-big-beautiful-bill-to-the-threshold-for-backup-withholding-on-certain-payments-made-through-third-parties?utm_source=openai))
## Practical Compliance Steps for Tax Professionals & Businesses
- **Update payroll systems** to accommodate separate reporting of overtime and tip deductions starting **2026**. For tax year 2025, ensure you have proper documentation: pay stub entries or statements that clearly identify qualified overtime or tips. ([irs.gov](https://www.irs.gov/newsroom/questions-and-answers-about-the-new-deduction-for-qualified-overtime-compensation?utm_source=openai))
- **Educate employees/site workers** about the new deductions—they may need to keep logs or be able to estimate their unreported tips. ([irs.gov](https://www.irs.gov/newsroom/treasury-irs-provide-guidance-for-individuals-who-received-tips-or-overtime-during-tax-year-2025?utm_source=openai))
- **TPSOs and platforms** should track number of transactions and gross payments per payee—ensure internal reporting systems align with thresholds of **$20,000 + 200 transactions**. ([irs.gov](https://www.irs.gov/newsroom/treasury-irs-issue-proposed-regulations-reflecting-changes-from-the-one-big-beautiful-bill-to-the-threshold-for-backup-withholding-on-certain-payments-made-through-third-parties?utm_source=openai))
- **Retain documentation**—if audited, IRS guidance requires records such as pay stubs, statements, logs showing the required amounts for tips/overtime. ([irs.gov](https://www.irs.gov/newsroom/treasury-irs-provide-guidance-for-individuals-who-received-tips-or-overtime-during-tax-year-2025?utm_source=openai))
## Example Scenarios for Compliance
- *Platform Seller*: Sara sells crafts on an online marketplace. She receives 180 transactions totaling $25,000. Under proposed rules, since number of transactions <200, backup withholding should **not** apply.
- *Gig Worker with Tips*: Carl bartends and has Form W-2 box 7 showing $10,000, plus unreported cash tips. He may gather his tip log and Form 4137 to claim up to $25,000 in qualified tip deduction if MAGI allows.
- *Overtime Worker*: Mike works 50 hours weekly; his employer pays 1.5× regular rate. The FLSA overtime premium portion (e.g., the “half-time” above regular pay) is the part eligible for deduction. For 2025, he should capture payroll statements; starting 2026, employers will report separately. ([irs.gov](https://www.irs.gov/newsroom/questions-and-answers-about-the-new-deduction-for-qualified-overtime-compensation?utm_source=openai))
## Key Takeaways
1. These are permanent compliance changes—plan your systems and recordkeeping now.
2. For 2025, benefit from transition relief, but documentation is crucial.
3. TPSOs need to understand new reporting thresholds to avoid over-withholding or errors.
4. Watch/comment on proposed regulations before finalization—comment periods give opportunity for input.
Aligning with these changes early can help minimize headaches and maximize deductions for both individuals and businesses.