The One Big Beautiful Bill Act (OBBBA) was signed into law on July 4, 2025, and it introduced several provisions that directly affect how employers handle payroll. Some of these changes were retroactive to January 1, 2025. Others are taking effect now in 2026 with new reporting requirements, updated withholding guidance, and state-level conformity legislation rolling out on different timelines.
If you manage payroll or oversee HR for your organization, here is a practical walkthrough of what changed, what it means for your payroll operations, and what you should be doing now.
The New Deductions That Affect Payroll
The OBBBA created several new above-the-line deductions that your employees can claim on their federal income tax returns. These are employee-side deductions, meaning employees claim them when they file their taxes. But each one creates new responsibilities on the employer side for tracking, reporting, and configuring payroll systems correctly.
Tips
Employees in occupations that customarily receive tips can now deduct up to $25,000 in qualified tips from their taxable income. The deduction is available for tax years 2025 through 2028 and phases out for individuals with modified adjusted gross income above $150,000 ($300,000 for joint filers).
What this means for employers:
- Reporting. Starting with tax year 2026, employers must report qualified tips separately on W-2 forms using a new Box 12 code. For 2025, this reporting was optional and employers could provide reasonable estimates.
- New W-2 fields. The 2026 W-2 includes a new Treasury Tipped Occupation Code (TTOC) in Box 14b. This is a new data point that payroll systems need to capture.
- FICA still applies. Qualified tips are still subject to Social Security and Medicare taxes. The deduction applies to federal income tax only. Your FICA calculations and remittances stay the same.
- Early prioritization is essential. Employers should ensure that these adjustments are made in Q2 or Q3 to avoid year-end headaches.
Overtime
Employees who receive qualified overtime compensation can deduct the premium portion of their overtime pay (the “half” in “time-and-a-half”) from their taxable income, up to $12,500 per year ($25,000 for joint filers). This deduction is also available for 2025 through 2028 and uses the same income phase-out thresholds.
Overtime miscalculations are one of the most common errors in payroll. The change for 2026 has added an additional layer of compliance. It is recommended that organizations use this change as an opportunity to examine all current overtime practices and system settings.
What this means for employers:
- Tracking. Your payroll system needs to separately track qualified overtime compensation, specifically the premium portion required under the Fair Labor Standards Act (FLSA). This means the extra half, not the base rate portion of overtime hours.
- Reporting. For 2026, the IRS is introducing a new Box 12 code (expected to be “TT”) on the W-2 for qualified overtime. Your system needs to capture and report this as a distinct line item.
- W-4 impact. Employees can adjust their W-4 withholding to account for the overtime deduction by adding estimated overtime to Line 4b. Encourage employees who regularly work overtime to update their W-4 for 2026.
- Withholding tables. The IRS is expected to update federal income tax withholding tables for 2026 to reflect the overtime deduction. This may affect how much is withheld from overtime pay going forward.
- Setup: With an additional compliance layer added, employers should examine their overtime practices and system settings.
Car Loan Interest
Individuals can deduct up to $10,000 per year in interest paid on loans used to purchase a qualifying vehicle for personal use. The loan must have originated after December 31, 2024, and the vehicle must have been originally used by the taxpayer. Lease payments do not qualify. The deduction phases out for taxpayers with modified adjusted gross income above $100,000 ($200,000 for joint filers).
What this means for employers:
This one is primarily an employee-side tax filing matter. There is no direct payroll reporting requirement for car loan interest. However, employees may adjust their W-4 withholding to account for this deduction, which could reduce their federal income tax withholding throughout the year. If you see a wave of W-4 updates, this is likely one of the reasons.
Other OBBBA Provisions Employers Should Know About
Student loan repayment assistance is now permanent.
The OBBBA made the employer-provided student loan repayment benefit permanent. Employers can contribute up to $5,250 per year toward an employee’s student loans, and that amount is excluded from the employee’s taxable income and payroll taxes. The limit will be indexed for inflation starting in 2027. If you already offer this benefit, nothing changes operationally. If you have been considering it, the permanent status makes it a stronger long-term option.
Dependent care assistance limit increased.
The annual limit on employer-provided dependent care assistance increased from $5,000 to $7,500 for most taxpayers (and from $2,500 to $3,750 for married individuals filing separately). This applies to taxable years beginning after December 31, 2025. If your organization offers a dependent care FSA or similar benefit, you may need to update your plan documents and payroll system limits.
Employer-provided childcare credit expanded.
The maximum employer credit for providing childcare facilities or services increased from $150,000 to $500,000, with a higher cap of $600,000 for eligible small businesses. This is a tax credit for the employer, calculated at tax filing time, but it may factor into benefits strategy conversations.
FICA tip credit expanded beyond food and beverage.
Employers have long been able to claim a federal income tax credit for their share of FICA taxes on employee cash tips in food and beverage establishments. The OBBBA permanently expands this credit to include beauty and personal care businesses where tipping is customary. If your organization operates in those industries, this is a new credit to factor into your tax planning.
State Conformity: The Layer Most Employers Miss
Federal tax law changes create a second set of decisions at the state level. Each state decides whether and when to conform to the new federal provisions, and the timelines vary.
In Q1 2026 alone, several states have already enacted conformity legislation:
- Indiana updated its IRC conformity date from January 1, 2023 to January 1, 2026, retroactively effective January 1, 2026. Indiana is also providing a state-level deduction equal to the federal deduction for qualified tips and overtime for tax year 2026.
- Ohio updated its conformity date to March 5, 2026, incorporating the OBBBA changes. Taxpayers with tax years ending between March 7, 2025 and March 5, 2026 can elect to apply the updated Code.
- West Virginia enacted conformity legislation covering federal changes made after December 31, 2024 and before January 1, 2026, retroactive where allowable.
- Virginia updated its interest rates for Q2 2026, with underpayment and overpayment rates both set at 8%.
More states will follow throughout 2026. Each conformity update can affect withholding calculations, deduction treatment, and reporting for employees in that state. For employers with workers in multiple states, this creates an ongoing compliance layer that needs to be monitored and applied as each state acts.
Ensuring compliance with state and local municipalities is not an annual event. States often phase in and out new requirements multiple times a year. Ensure you have a process in place to stay on top of and execute these updates, or a partner to work with who can ensure updates are being provided and your payroll system is in sync.
The Updated IRS Withholding Estimator
The IRS updated its online Tax Withholding Estimator in March 2026 to reflect the OBBBA changes, including the new deductions for tips, overtime, and car loan interest, as well as the senior deduction. The estimator helps employees determine whether they should submit a revised W-4 or W-4P.
This is worth sharing with your workforce. Employees who earn tips or regularly work overtime may benefit from updating their withholding to reflect these new deductions. A quick internal communication pointing employees to the IRS estimator (irs.gov/W4App) can help them get their withholding closer to where it should be and reduce surprises at tax time.
What Employers Should Be Doing Now
The OBBBA creates a manageable set of action items for most employers. Here is a practical checklist:
- Confirm your payroll system can separately track qualified overtime. The premium portion of FLSA-required overtime needs to be captured as a distinct data point for W-2 reporting in 2026.
- Verify tip reporting capabilities. If you have tipped employees, your system needs to handle the new Box 12 code and the Treasury Tipped Occupation Code in Box 14b.
- Review your W-2 setup for 2026. The IRS has released draft 2026 W-2 forms with new Box 12 codes. Make sure your payroll provider or system is prepared for these changes.
- Communicate with employees about W-4 updates. Share information about the new deductions and point employees to the IRS Withholding Estimator. Employees who earn tips or overtime may want to adjust their withholding.
- Monitor state conformity updates. If you operate in multiple states, track which states have conformed to the OBBBA and when those changes take effect. Each conformity update may require a configuration adjustment in your payroll system.
- Update dependent care FSA limits if applicable. The new $7,500 annual limit applies to plan years beginning after December 31, 2025.
- Review FLSA classifications. The overtime deduction applies only to overtime required under the FLSA. Confirm that your employee classifications (exempt vs. non-exempt) are accurate and that your overtime calculation method aligns with FLSA requirements.
Keeping Up with the Changes
Legislation like the OBBBA is a good example of why payroll is more than processing. Every new provision creates a chain of updates: federal reporting changes, withholding adjustments, state conformity legislation, system configuration, and employee communication. Staying on top of all of it takes ongoing attention.
Employers Council’s payroll team monitors these changes as they happen and applies them to client configurations before the next pay cycle. If your organization is managing payroll across multiple states, working through OBBBA system updates, or simply looking for a team to handle the details, we would like to hear about your situation. Reach out at info@employerscouncil.org or call 800.884.1328 to get started.