When Congress passed the One Big Beautiful Bill Act (OBBBA) this summer, few realized just how much it would shake up payroll. What started as a sweeping tax and wage reform designed to put more money into employees’ pockets has turned into a practical challenge for employers, payroll providers, and accountants across the country. As IRIS’ Payroll Tax and Compliance Lead, Loreene Kemperman, explains, “When they signed the One Big Beautiful Bill, Act, every payroll service bureau in the country went into panic mode.”
The reason? The law went into effect retroactively to January 1, even though it wasn’t signed until midyear. That’s left employers scrambling to comply with new reporting requirements, deduction changes, and unclear IRS guidance.
How the OBBBA Impacts Payroll Compliance
The BBB introduced three major changes that directly affect payroll operations:
1. Overtime Deductions.
Under the new law, qualified overtime—that is, overtime governed by Section 7 of the Fair Labor Standards Act—is now deductible for employees. But only the half-time premium portion qualifies, not the full “time and a half” rate.
As Kemperman explains, “If you get $10 an hour and now you’re working overtime at $15, employees will be confused because they can’t deduct that full $15. They can only deduct the $5.” To make things even more complicated, states calculate overtime differently, and some don’t align with federal Section 7 rules. California, for example, defines overtime as hours worked over eight in a day, not forty in a week, meaning those daily overtime hours don’t qualify for the federal deduction.
2. Tip Deductions.
The BBB also made qualified tips deductible, which sounds simple until you read the fine print. The IRS provided a draft list of 80 “traditionally tipped occupations,” including servers and bartenders, hairstylists, and hotel staff. But the details of what counts as a qualified tip remain murky.
“The IRS likes the definition of voluntary tips as those freely given by the customer,” says Kemperman. “What’s not deductible are involuntary tips like service charges or bottle fees automatically added by a business.”
Further complicating matters, tips in non-cash forms, such as crypto or property, don’t qualify at all. “It’s unlikely anyone’s tipping in horses or yachts,” Kemperman laughs, “but yes, technically, crypto counts as property and can’t be deducted.”
3. Expanded Reporting Requirements.
The BBB’s retroactive start date created a logistical nightmare. Federal W-2 and 1099 forms for 2025 had already been sent to print before the bill passed, leaving no room for design changes and forcing payroll providers and platforms, including IRIS Global, to improvise.
“To meet the requirement that employers notify employees of their qualified tips and overtime, we’re reporting them in Box 14 on the W-2,” says Kemperman. “It’s not perfect, but every employee gets a W-2, so it’s the cleanest way to meet the law’s intent.”
In short: the OBBBA changes what’s deductible, how it’s reported, and who’s responsible for ensuring it’s done correctly, all without clear final guidance from the IRS.
Common Payroll Compliance Pitfalls to Avoid
While the industry awaits further IRS clarification, employers can take proactive steps to minimize compliance risks. The OBBBA has exposed common problem areas that now carry higher stakes:
Employee Misclassification. Misclassifying workers as exempt or nonexempt affects overtime eligibility and, by extension, an employee’s ability to claim deductions. “If you misclassify someone and tell them they’re not overtime-eligible when they actually are, you’ve taken a deduction away from them,” warns Kemperman. “Penalties for misclassification have gone up.”
Contractor Confusion. In an unexpected twist, the OBBBA opened the door for contractors to potentially be eligible for overtime and tip deductions. “I’ve never seen that before,” Kemperman says. “Even if you’re working as an independent contractor, you could negotiate tips or overtime into your contract.” That’s new territory for payroll teams and a potential compliance minefield.
Inconsistent State Laws. Each state must now decide whether to align with the federal OBBBA rules. Some, like Michigan, have chosen to follow federal guidelines. Others, like Alabama, had existing laws that have since expired or conflicted. That patchwork of rules means multi-state employers will need to monitor developments closely.
Steps to Ensure Payroll Compliance Under the OBBBA
Until the IRS provides additional direction, payroll experts recommend focusing on preparation and documentation.
1. Conduct a Payroll Audit
Now is the time to review how overtime and tips are calculated, classified, and reported. Make sure your system distinguishes between voluntary and involuntary tips, properly identifies Section 7 overtime, and excludes ineligible categories like shift premiums or double time.
2. Update or Upgrade Your Payroll Software
The BBB’s complexity underscores the value of a modern, adaptable payroll platform. IRIS Global, for example, is already preparing its three payroll systems to handle these changes automatically.
“All three of our platforms will clearly define and extract the half-time portion of federal overtime,” says Kemperman. “We’re also building a new tip type to separate out involuntary tips and track qualified ones under the new IRS occupation codes.”
3. Train Your HR and Payroll Teams
The new rules don’t just affect software. They impact how HR teams classify jobs, process overtime, and communicate with employees. Train staff on identifying qualified tips and overtime and on explaining these deductions to workers who may be confused come tax time.
4. Document Everything
As IRS guidance continues to evolve, maintaining thorough records will help demonstrate good-faith compliance. Document how your business defines and tracks qualified overtime and tips, and retain communication showing you advised employees as required.
5. Stay Proactive, Not Reactive
Payroll providers are operating in a state of “organized uncertainty.” The IRS received more than 2,000 public comments on the OBBBA’s tipped-income provisions, but those responses remain unreviewed due to the government shutdown.
“We’re all waiting on the IRS,” Kemperman says. “Every payroll provider, every tax preparer, we all have the same big questions and no final answers. So we’re making our best estimates to get something into the system now, rather than waiting and forcing clients to backfill data later.”
For employers, that proactive mindset can prevent chaos at year-end. Updating systems now means avoiding the scramble of retroactive corrections once new forms and rules are finalized.
Looking Ahead
While the OBBBA’s intent to give workers more take-home pay through new deductions is clear, its implementation remains a moving target. Payroll experts like Kemperman expect additional IRS forms and code updates by mid-2026. “We’re planning now so that our customers don’t have to go back later and fill in missing data,” she says. “The more we can automate and clarify up front, the smoother year-end will be.”
For employers still running payroll manually or with outdated systems, the OBBBA may be the push needed to modernize. Between new reporting boxes, tip codes, and deduction logic, the cost of noncompliance could quickly outweigh the cost of upgrading.
“Every employer should be asking their payroll provider how they’re handling OBBBA compliance,” Kemperman advises. “If the answer is uncertain or delayed, that’s your cue to look for a provider who’s staying ahead of the curve.”
Payroll compliance has always required precision. But under the One Big Beautiful Bill Act, it also demands agility. With definitions still in flux, IRS systems catching up, and state laws diverging, the best approach is one grounded in preparedness and transparency.
At IRIS, that’s exactly the mission. “We’re committed to helping our clients stay compliant, no matter how unclear the guidance may be,” says Kemperman. “Because in payroll, getting it right isn’t just about taxes. It’s about trust.”
Need help navigating the One Big Beautiful Bill Act? IRIS’s payroll experts are already building solutions to ensure your business remains compliant with every new requirement. Take the next step toward smarter payroll—explore our payroll solutions and see how we can support your business.