Few tax changes have created as many questions at local restaurants, salons, warehouses and service businesses as the new federal deductions for tips and overtime. This no tax on tips and overtime Union City guide explains what the One Big Beautiful Bill Act actually changed, who qualifies, what employers must show on 2026 Forms W-2, and why California tax returns are a different story.
It is written for owners, payroll managers and employees in Union City and the Tri-City area, including Fremont and Newark, as well as Hayward, San Leandro, Castro Valley and the wider Bay Area. With 2026 year-end payroll only weeks away, now is the time to make sure your payroll system can separate qualified tips and qualified overtime before the first W-2 is printed.
What the One Big Beautiful Bill Act Changed
According to the IRS, the law signed on July 4, 2025 (Public Law 119-21) created two new deductions that apply for tax years 2025 through 2028. The IRS summarizes both in its fact sheet on deductions for working Americans and in Publication 6133.
- No tax on tips: employees and self-employed individuals may deduct up to $25,000 of qualified tips received in occupations the IRS lists as customarily and regularly receiving tips on or before December 31, 2024.
- No tax on overtime: individuals may deduct the part of overtime pay required by section 7 of the Fair Labor Standards Act (FLSA) that exceeds their regular rate, generally the “half” in “time-and-a-half,” up to $12,500 ($25,000 for joint filers).
Both deductions phase out for taxpayers with modified adjusted gross income over $150,000 ($300,000 for joint filers). They are available whether a taxpayer itemizes or takes the standard deduction, require a Social Security number valid for employment, and require married taxpayers to file jointly. Workers claim them on Schedule 1-A of Form 1040, Part II for tips and Part III for overtime.
The key word is deduction. Tips and overtime are not excluded from wages. The IRS 2026 Form W-2 instructions say tips are generally still subject to federal income tax withholding and to both the employer and employee shares of Social Security and Medicare tax if tips received are $20 or more per month, and overtime is still generally subject to withholding and to both shares of Social Security and Medicare tax. Your payroll tax deposits do not get smaller because of these rules.
Who Qualifies for the Tips Deduction
Qualified tips
The IRS tip recordkeeping and reporting page defines qualified tips as voluntary cash tips received in an occupation that customarily and regularly received tips on or before December 31, 2024. Cash tips include tips paid by cash, check, credit or debit card, gift card and electronic or mobile payment. Tips received from coworkers through a tip pool or tip-sharing arrangement also count.
The IRS publishes the list on its Treasury Tipped Occupation Codes page. It is broader than many people expect. Along with bartenders, wait staff, bussers, cooks, baristas and hosts, it includes barbers and hairstylists, manicurists, massage therapists, personal trainers, rideshare drivers, delivery drivers, home cleaners, plumbers and electricians doing home service work, movers, pet groomers, tutors, private event and portrait photographers, and digital content creators, among others.
Service charges are not tips
This is the point Bay Area restaurants most need to get right. The IRS says mandatory service charges are not tips and do not qualify. Service charges distributed to employees are wages, not tips. The IRS gives these examples of service charges:
- An automatic charge added to a bill, such as a mandatory 18% charge for large parties.
- Required gratuities written into a contract or invoice, such as a banquet or catering contract.
- Digital payment prompts that require the customer to choose a tip greater than zero before paying.
Suggested tip amounts on a receipt are fine, as long as the customer can enter any amount or leave the line blank. If a Union City restaurant adds an 18% service charge and the customer voluntarily adds more, only the extra voluntary amount is a tip.
Self-employed workers
Self-employed people who receive tips, such as independent stylists, rideshare drivers and gig workers, can also qualify. For them, the deduction cannot exceed net income from the business in which the tips were earned, and tips received in a specified service trade or business are excluded, although the IRS has provided transition relief on that restriction for workers in listed tipped occupations.
Who Qualifies for the Overtime Deduction
The overtime deduction only covers overtime required by the federal FLSA. The IRS overtime FAQs (FS-2026-13) explain that for most employees, qualified overtime for a workweek is figured as FLSA hours worked over 40, times one-half, times the employee’s FLSA regular rate of pay.
Several groups do not receive qualified overtime at all, including employees who are exempt from FLSA overtime, such as many executive, administrative and professional employees and certain computer-related employees. The IRS also says an employee who owns at least a bona fide 20% equity interest in the business and is actively involved in managing it is generally an exempt executive, so most owner-employees of small S corporations will not have qualified overtime.
California Daily Overtime: The Union City Trap
California overtime rules are more generous than federal rules. According to the California Labor Commissioner’s overtime FAQ, nonexempt adult employees generally earn time-and-a-half for hours over 8 in a workday and over 40 in a workweek, and double time for hours over 12 in a workday, with special rules for the seventh consecutive day of work.
The federal deduction does not follow California’s rules. The IRS says overtime paid because of state law, a union contract or employer policy, such as a premium for hours beyond 8 on a workday, is not qualified overtime unless the FLSA also requires it. If an employer pays double time, only the amount minimally necessary to satisfy the FLSA is qualified. In the IRS example, an employee earning $20 an hour who works 50 hours and is paid double time for 10 overtime hours has $100 of qualified overtime, not the full $200 premium.
Here is how that plays out for a Union City employer, assuming a simple hourly wage and no bonuses or other pay that change the regular rate:
- Four 10-hour days (40 hours): under the general California rule, the employee may earn 8 hours of daily overtime, but there are no FLSA hours over 40, so qualified overtime is $0 under the IRS formula.
- Five 9-hour days (45 hours) at $30 per hour: the employee earns California daily overtime, but the FLSA formula counts only the 5 hours over 40: 5 x 0.5 x $30 = $75 of qualified overtime for that week.
Your payroll system must calculate the FLSA overtime premium separately from the California overtime it actually pays. Most payroll systems were not built that way, so check your settings well before December. If you need help, our payroll services team can review your earning codes and year-end setup.
2026 Form W-2 Reporting: Codes TP, TT and Box 14b
For 2025, the IRS gave employers transition relief from the new reporting rules. For 2026, the 2026 General Instructions for Forms W-2 and W-3 add new reporting that every employer with tipped or overtime-eligible staff needs to follow:
- Box 12, code TP: the total amount of cash tips reported to the employer. Reported tips are also still included in box 1, box 5 and box 7.
- Box 14b, Treasury Tipped Occupation Code(s): required when cash tips are reported with code TP. Enter up to two codes for the occupations in which tips were received. If any tips were received in a nonqualifying occupation, code 000 must be one of the codes. Box 14 is now split into 14a (Other) and 14b.
- Box 12, code TT: the total amount of qualified overtime compensation, meaning only the FLSA-required amount above the regular rate, such as the “half” of time-and-a-half.
The IRS FAQs stress that code TT shows the full qualified overtime paid, even if it is more than the employee can deduct. If an employee received $30,000 of qualified overtime in 2026, the employer reports $30,000 in code TT, even though the deduction is capped at $12,500 ($25,000 on a joint return).
Accuracy matters more than usual this year. The IRS says that for tax years after 2025, employees can only deduct qualified overtime that the employer included on a properly furnished Form W-2, and a substitute Form 4852 cannot be used for this deduction. If an employer discovers an error in code TT, it must file Form W-2c with the SSA and furnish it to the employee as soon as possible, and incorrect forms can lead to information reporting penalties.
The deadline does not move. Under the 2026 W-2 instructions, employers must furnish Forms W-2 to employees and file them with the SSA by February 1, 2027. For more on the rest of the year-end payroll process, see our Hayward year-end payroll checklist for W-2 and 1099-NEC prep.
Contractors and Form 1099
Businesses that pay independent contractors must separately report tips paid in the course of a trade or business on Forms 1099-NEC, 1099-MISC and 1099-K, with the applicable occupation code, according to the IRS. Qualified overtime is reported on Form 1099-NEC (box 1d) or 1099-MISC (box 14) only in the rare case where the worker is an employee for FLSA purposes but treated as an independent contractor for federal tax purposes.
Withholding: Federal Form W-4 vs. California DE 4
Employers do not automatically reduce federal withholding for these deductions. According to IRS Publication 15, employers must use an employee’s updated Form W-4, if the employee submits one, so the employee can account for the expected deduction in each paycheck. The IRS overtime FAQs note the 2026 Form W-4 lets employees account for the overtime deduction in step 4(b).
California is separate. The EDD Form DE 4 instructions say the federal Form W-4 is used for federal withholding only, and employees must file a DE 4 for California personal income tax withholding. The FTB also says it does not conform to the federal requirement to modify withholding calculations. In practice, a Union City server who lowers federal withholding with a new W-4 should not expect any change to California withholding. Under the EDD tips information sheet (DE 231T), reported tips of $20 or more in a month are wages subject to California UI, ETT, SDI and personal income tax withholding.
Does California Conform? No.
The FTB Summary of Federal Income Tax Changes answers this directly. For the no tax on tips provision, the answer is “No, with respect to the deduction on tips provisions” and “Yes, with respect to the information return provisions.” The overtime provision gets the same answer. The FTB explains that these federal changes were added after California’s January 1, 2025 conformity date, so California does not allow the deductions.
For a Hayward bartender, a Fremont warehouse lead or a Newark nail technician, that means:
- Qualified tips and qualified overtime can lower federal taxable income for 2025 through 2028.
- The same tips and overtime stay fully taxable on the California return.
- The new W-2 information is still reported, and California conforms to the information-return provisions.
That federal-state split is the most common point of confusion in no tax on tips and overtime Union City questions. Workers who expect a smaller federal bill should not assume their state bill will shrink too. If you also have side income, review your California estimates; our Q4 estimated tax guide for Union City covers the January 15, 2027 payment.
No Tax on Tips and Overtime Union City Employer Checklist
Use this list between now and the February 1, 2027 W-2 deadline:
- List every tipped role and match it to a Treasury Tipped Occupation Code. Flag any role that is not on the IRS list (code 000).
- Separate voluntary tips from service charges and auto-gratuities in your POS and payroll, and treat service charges as wages.
- Make sure tipped employees report cash tips by the 10th of the following month, as the IRS requires when tips are $20 or more in a month.
- Confirm which employees are FLSA overtime-eligible, and remember that exempt staff and 20% owner-managers generally are not.
- Set up a separate earning code or report for the FLSA overtime premium (hours over 40 x 0.5 x regular rate), apart from California daily overtime and double time.
- Test a December payroll and a draft W-2 to confirm box 12 codes TP and TT and box 14b populate correctly.
- Honor updated federal Forms W-4, and keep California DE 4 withholding separate.
- Furnish and file 2026 Forms W-2 by February 1, 2027, and correct any code TT error with Form W-2c.
Some businesses have extra tip rules. The IRS says a large food or beverage establishment, which among other tests normally employed more than 10 employees on a typical business day in the prior year, must file Form 8027, and the new law extended the employer FICA tip credit (Form 8846) to certain tips received by employees providing barbering and hair care, nail care, esthetics, and body or spa treatment services. Our Bay Area restaurant bookkeeping and tax checklist covers year-end bookkeeping for food and beverage businesses. Employers planning 2027 raises should also review our Union City minimum wage 2027 payroll checklist, because a higher hourly rate also increases the overtime premium.
What Union City Employees Should Do
- Check your occupation against the IRS tipped occupation list if you receive tips.
- Keep a daily tip record and report cash tips to your employer on time.
- Review your January 2027 Form W-2 for box 12 codes TP or TT and box 14b. If an amount looks wrong, ask for a Form W-2c.
- Consider an updated Form W-4 if you expect a large deduction in 2027 and want more in each paycheck.
- Plan for California tax, which still applies to all of your tips and overtime.
- Work with a preparer on Schedule 1-A, especially if your income is near the $150,000 or $300,000 phase-out thresholds. Our tax preparation team handles these returns every season.
No Tax on Tips and Overtime Union City FAQs
Are tips and overtime really tax-free in 2026?
Not completely. The One Big Beautiful Bill Act created federal income tax deductions for qualified tips and qualified overtime for tax years 2025 through 2028. Tips and overtime are still reported as wages, are still subject to Social Security and Medicare tax, and generally still have federal income tax withheld unless the employee updates Form W-4. Eligible workers then claim the deductions on Schedule 1-A of Form 1040.
How much can I deduct for tips and overtime?
The qualified tips deduction is capped at $25,000 per return. The qualified overtime deduction is capped at $12,500, or $25,000 on a joint return. Both phase out for modified adjusted gross income over $150,000 ($300,000 for joint filers). A valid Social Security number is required, and married taxpayers must file jointly. The deductions are available whether you itemize or take the standard deduction.
Does California allow the no tax on tips and overtime deductions?
No. The Franchise Tax Board says California does not conform to the federal deduction for tips or the federal deduction for overtime pay, so Union City and other California residents still report tips and overtime as fully taxable on the state return. California does conform to the new information-return provisions, and the FTB does not conform to the federal change in withholding calculations.
Does California daily overtime count as qualified overtime?
Generally only the portion required by the federal Fair Labor Standards Act counts. The IRS says overtime paid because of state law, a union contract or employer policy, such as a premium for hours beyond 8 in a workday, is not qualified overtime unless the FLSA also requires it. For double time, only the amount minimally necessary to satisfy the FLSA, usually the half-time premium on hours over 40 in a workweek, is qualified.
What do employers report on 2026 Forms W-2?
For 2026, employers report total cash tips reported to the employer in box 12 with code TP and enter up to two Treasury Tipped Occupation Codes in new box 14b. Qualified overtime compensation goes in box 12 with code TT. The full qualified amount is reported even if it exceeds the employee deduction limit. 2026 Forms W-2 are due to employees and to the SSA by February 1, 2027.
What if my W-2 does not show my overtime correctly?
Ask your employer for a corrected Form W-2c. The IRS says that for tax years after 2025, employees may only use qualified overtime reported on Form W-2, box 12, code TT, and a substitute Form 4852 cannot be used for this deduction. Employers that discover an error in code TT must file and furnish Form W-2c as soon as possible.
Get Help With No Tax on Tips and Overtime Union City Reporting
The new deductions can put real money back in employees’ pockets, but only if payroll reports the right amounts. Accountico helps restaurants, salons, contractors and growing employers in Union City, Fremont, Hayward, Newark, San Leandro, Castro Valley and across the Bay Area set up tip and overtime tracking, review W-2 codes before filing and plan for the difference between federal and California tax. We also offer bookkeeping services and tax strategy and planning for owners who want year-round support.
Book a free 30-minute consultation or contact our team to review your 2026 payroll setup.
Accountico Inc
33476 Alvarado Niles Rd, Ste A007, Union City, CA 94587
(510) 400-9341
Disclaimer: This article is general information for employers and workers and is not tax, legal, payroll or accounting advice. Tax rules and IRS guidance change, and individual situations differ. Confirm requirements with the IRS, the California Franchise Tax Board, the EDD, or a qualified tax professional before acting.
