Chicago Business Attorney Blog
A new federal law, officially titled the One Big Beautiful Bill Act, has introduced significant tax changes that directly impact employers in service-based industries. The legislation, signed into law on July 4, 2025, offers new income tax deductions for employees who earn tips and overtime pay, while also expanding tax credits for certain
employers. Businesses that rely on tipped or hourly labor should take a close look at how these changes affect their operations.
Tip Deductions for Employees, But Reporting Still Matters
Under the new law, employees who work in traditionally tipped roles can now deduct up to $25,000 in reported tips from their federal income taxes. This above-the-line deduction is available even if the taxpayer does not itemize.
However, this isn’t a free pass—tips must still be reported and remain subject to payroll taxes. Only tips that are properly documented through IRS forms, including W-2s or Form 4137, are eligible. The deduction phases out for individuals earning over $150,000 and couples earning over $300,000.
To qualify, the tips must come from a role that customarily received tips prior to 2025, such as restaurant servers, bartenders, hairstylists, and others to be listed by the Treasury Department.
– Employer Action Point: Ensure your payroll and time-tracking systems accurately
record employee tip income and are aligned with IRS reporting standards.
Misreporting could disqualify your employees from claiming this deduction—and
may expose your business to penalties.
What Counts as a Tip?
The law preserves existing definitions of tips under federal wage regulations. That means the payment must be voluntary, not subject to negotiation, and given at the discretion of the customer. Automatic service fees or “gratuity charges” added to a bill, such as those for large parties or spa packages, do **not** count as deductible tips.
In addition, sharing pools are still permitted, and amounts distributed through those systems can qualify as deductible tips if reported correctly.
Expanded Employer Tip Credit for More Industries
For employers, one of the most noteworthy provisions is the expansion of the federal tip credit under Section 45B of the Internal Revenue Code. This credit has traditionally been limited to businesses in the food and beverage industry. Now, it extends to additional service sectors, including:
– Barbering and hairstyling
– Nail and skincare services
– Massage therapy and spa treatments
If your business falls into one of these categories, you may be able to claim a credit for FICA taxes paid on tipped wages. However, this requires proper reporting and compliance with both wage and tax laws.
Overtime Pay Gets a Tax Break Too
In addition to tip deductions, the law also allows workers to deduct a portion of their overtime wages, up to $12,500 for individuals and $25,000 for married couples, from federal income taxes. This applies only to overtime required under federal law (typically hours worked beyond 40 per week) and is available through the 2028 tax year. As with tip income, overtime pay remains subject to payroll taxes and must be properly
documented to qualify.
– Note for Employers: While this deduction applies to employees, it may indirectly affect your HR and payroll systems. Now is a good time to revisit your overtime tracking and ensure compliance with the Fair Labor Standards Act (FLSA).
Preparing Your Business for What’s Ahead
These new provisions may benefit both employees and employers, but only if the rules are followed carefully. Businesses should take steps now to:
– Review payroll and tip-reporting processes
– Ensure workers are classified correctly under wage laws
– Determine eligibility for the expanded tip credit
– Provide guidance to employees who may wish to claim these deductions
Though the tax breaks are scheduled to sunset after 2028, they may set a precedent for how service-sector compensation is treated in the long run.
Have Questions About the New Law?
The attorneys at Bellas & Wachowski help small businesses navigate the intersection of employment law and tax compliance. Contact us at 800-825-9260 to learn how these changes may impact your workforce and your bottom line.