Article originally published by UKG
The One Big Beautiful Bill Act (OBBBA) is reshaping how organizations track, classify, and report two core elements of pay: tips and overtime. While the 2025 tax year came with a one-time IRS penalty relief window for certain reporting elements, 2026 is the first year employers should plan for accurate, consistent reporting without assumed relief.
Whether you run payroll for a restaurant group, a nationwide retailer, a hospitality brand, or any organization relying on tipped or overtime-earning employees, now is the time to modernize processes and prepare your systems. The IRS has said tax year 2025 is being treated as a transition period and that the penalty relief is limited to tax year 2025, so employers should plan for standard compliance expectations for 2026 wages.
The following breaks down what’s changed, what’s known today, and how payroll leaders can get ahead of 2026 before year-end pressure makes it harder to pivot.
How the OBBBA changes the game for payroll
OBBBA introduces new employee deductions tied to tips and qualified overtime, creating ripple effects across payroll calculations, reporting, and reconciliation. Specifically, employers must be prepared to:
- Track cash tips (which includes tips received in cash, charged tips, and tips received through a tip-sharing arrangement) in new ways
- Distinguish qualified overtime compensation from other premium pay (for FLSA overtime paid at one-and-a-half times the regular rate, the qualified overtime amount is the half premium portion above the regular rate)
- Report both separately as reflected in updated IRS information reporting guidance
- Capture or maintain clear occupation data for tipped workers using Treasury tipped-occupation codes
This isn’t just another incremental compliance adjustment. It’s a structural shift that affects earning codes, timekeeping rules, data validation, employee training, and how information flows to the IRS.
The IRS has made one thing clear: 2025 was your grace period, but not your exemption. In November 2025, the agency granted penalty relief for tax year 2025 reporting errors as long as filings are on time and that relief does not extend to 2026 wages. The IRS also stated that Forms W-2 and 1099 for tax year 2025 were not updated for these changes. That’s part of why 2025 functioned as a transition year, giving employers time to build the required data and reporting processes ahead of 2026 wages.
2026: The first year with normal enforcement expectations
Because 2025 functioned as a “dry run,” employers have a narrow window to ensure that their:
- Payroll and workforce management systems can collect the required data
- Earning codes accurately categorize tips and qualified overtime
- Treasury tipped-occupation data is maintained in a structured format that can support expected reporting draft and final IRS reporting formats as instructions are finalized
- Year-end outputs will align with currently available draft IRS reporting formats and ready to adjust when final instructions are issued
Legal and industry analyses — backed by the IRS’s draft 2026 Form W-2 — frame 2026 as the first year employers should assume normal penalty exposure when they fill out W-2 forms after the transition year. Waiting until mid-2026 to react will create unnecessary pressure, and payroll is the last place organizations can afford to play catch-up.
What we know today about IRS expectations
- Distinct reporting of tips and qualified overtime: IRS guidance and draft reporting formats confirm OBBBA requires employers to separately track reportable tips and qualified overtime amounts that form the basis of employee deductions.
- Tipped-occupation data for workers: The IRS draft 2026 Form W-2 instructions include a Box 14b area for up to two Treasury Tipped Occupation Code(s), used with the tip amount reported in Box 12 (code TP).
- Updated year-end reporting formats still pending
While the draft 2026 W-2 shows new boxes for reporting, the IRS continues to finalize instructions. Employers should plan around the draft structure and adjust as final instructions are released.
- No penalty relief in 2026: IRS Notice 2025-62 penalty relief applies only to tax year 2025 (it does not cover 2026 wages).
- Increased scrutiny on data accuracy: Because OBBBA payroll compliance relies on more granular tracking of wage categories, employers should expect heightened emphasis on data completeness and accuracy.
Five areas payroll leaders should prioritize for 2026
- Systems and data structure
Assess whether your systems can:
- Capture separate values for reportable tips
- Distinguish qualified overtime
- Store Treasury tipped-occupation codes
- Map earnings to future IRS reporting formats
- Timekeeping and scheduling rules
Your reporting is only as accurate as your timekeeping inputs. Review whether your timekeeping system:
- Supports detailed tip reporting
- Correctly classifies overtime types
- Enforces consistent processes across locations
- Policies, processes, and manager training
Update policies to reflect OBBBA expectations, including:
- How employees report tips
- How overtime is approved and classified
- How errors are escalated and corrected
- Year-end reconciliation and audit readiness
Use 2025 as a reconciliation test year:
- Compare projected OBBBA output against payroll system totals
- Validate classification accuracy
- Confirm occupation data is maintained consistently
- Employee education and change management
Employees will notice new categories and codes on their pay statements. Proactive communication from you will reduce employee confusion and payroll inquiries.
What’s still pending and how to prepare
The IRS is expected to release:
- Final 2026 Form W-2 instructions
- Examples to illustrate tip and overtime qualifications
- Clarifications on edge-case reporting
- Finalized data fields and box numbers
Instead of waiting, build systems now with placeholders that can be updated once final details are published.
Using 2025 as your test year
2025 served as the transition year the IRS intended — a period for employers to prepare without penalty. During that time, organizations should have used the opportunity to:
- Run trial OBBBA-style reports
- Validate data accuracy
- Test mapping against projected year-end outputs
- Identify and correct systemic issues ahead of 2026 enforcement
This transition period was designed to help employers adjust systems, refine processes, and enter 2026 ready for updated reporting expectations.
In summary
OBBBA is a significant shift — not a minor tweak — in how payroll organizations must manage tipped and overtime compensation. Employers that used 2025 strategically are entering 2026 more prepared and confident. Those who didn’t may find themselves scrambling as normal reporting expectations take effect.
Preparing for OBBBA payroll compliance isn’t just about meeting new reporting rules. It also requires accurate data, consistent processes, and systems that can adapt as guidance evolves.
Many organizations will lean on HR and payroll services and on HR services Baton Rouge employers already trust to update systems and processes for OBBBA.
Download our OBBBA Payroll Compliance Checklist to help prepare your payroll systems, codes, and reporting for full 2026 OBBBA payroll compliance and upcoming IRS requirements.
