Key Employee Payroll and Tax Changes for 2026 (OBBBA)

The Overtime and Benefit Balance Act (OBBBA) represents one of the most significant payroll and tax law changes for employees in recent years. Whether you earn overtime, receive tips, or use transit benefits, these updates could put real money back in your pocket—or at least reduce what you owe come tax time. We’ve distilled the key provisions below so you know what to expect and how to plan. As always, the details matter, so reach out if you’d like to discuss how these changes apply to your specific situation.

• Overtime Deduction: Employees may deduct up to $12,500 ($25,000 if married filing jointly) of the “half” portion of FLSA overtime premium pay on their personal tax return (Form 1040, Schedule 1). This deduction is subject to income phase-outs and does not reduce Social Security or Medicare (FICA) taxes withheld from your paycheck. The deduction is taken at year-end and reduces your taxable income for federal income tax purposes only.
• Tip Income Deduction: Employees in IRS-listed tipped occupations may deduct up to $25,000 of qualified tips per year, claimed as an above-the-line deduction on Form 1040, Schedule 1. Only voluntary tips in eligible occupations qualify; tips remain subject to FICA and payroll tax withholding.
• Transportation Fringe Benefits: The monthly exclusion for qualified transit and parking benefits increases to $340 for 2026. Amounts within the limit are not subject to federal income tax or FICA and are excluded from your taxable wages on Form W-2.
• FICA Tip Credit and Paid Family & Medical Leave Credit: These credits are for employers only and do not provide a direct tax benefit to employees. However, you may benefit from expanded paid leave or improved employer policies as a result.
• Withholding and Forms: For 2026, new W-4 and W-2 forms will allow you to adjust your withholding to account for the new deductions. For 2025, no changes to payroll withholding or reporting are required, but you may need to provide supplemental information to your tax preparer.
• Transition Relief for 2025: Employers have a transition period for reporting changes in 2025, but employees may still claim the new deductions on their 2025 tax returns.

What Employees Need to Know: The Breakdown of the OBBBA Payroll Changes for 2026

The Overtime and Benefit Balance Act (OBBBA) brings meaningful tax relief for workers who earn overtime, receive tips, or use commuter benefits. If any of these apply to you, here’s how the new rules could affect your paycheck—and your tax return.

Overtime Workers: A New Above-the-Line Deduction

If you’re a nonexempt employee who earns FLSA overtime, you may be able to deduct up to $12,500 (or $25,000 if married filing jointly) of your overtime premium pay on your federal tax return.

Here’s the catch: Only the “half” portion of your time-and-a-half pay qualifies—not your entire overtime earnings. This deduction phases out for individuals earning more than $150,000 ($300,000 for joint filers), and it won’t reduce your FICA or payroll taxes. You’ll still see those withheld from your check; the benefit comes when you file your return.

What to expect: Look for a new code (TT) in Box 12 of your W-2 that tracks your qualified overtime.

Tipped Employees: Keep More of What You Earn

Workers in IRS-designated tipped occupations can now deduct up to $25,000 in qualified tips annually. This is an above-the-line deduction, meaning it reduces your adjusted gross income directly.

What qualifies? Treasury has identified eight categories of tipped occupations, including:

• Beverage and Food Service
• Entertainment and Events
• Hospitality and Guest Services
• Home Services
• Personal Services
• Personal Appearance and Wellness
• Recreation and Instruction
• Transportation and Delivery

Important: Only voluntary tips count. Mandatory service charges—like that automatic 18% gratuity for large parties—don’t qualify. Your tips must also be reported properly (look for Code TP in Box 12 of your W-2).

Commuter Benefits Just Got Better

The monthly exclusion for qualified transit and parking benefits increases to $340 per month for 2026. If your employer offers these benefits, amounts up to this limit are excluded from both your taxable wages and FICA taxes. No action needed on your tax return unless your benefits exceed the cap.

Employer-Only Credits (But You Might Still Benefit)

Two provisions—the FICA Tip Credit expansion and the Paid Family & Medical Leave Credit—apply only to employers. While you won’t see a direct tax break, these credits may encourage your employer to offer more generous paid leave policies or expand tipped positions.

What You Should Do Now

Update your W-4: For 2026, the IRS will release updated withholding forms that account for these new deductions. Adjusting your withholding can help you avoid a big refund (or bill) at tax time.

Talk to your tax preparer: If you earned overtime or tips in 2025, you can claim these deductions on your 2025 return—even though your employer won’t have updated W-2 reporting yet. Gather your records and let your preparer know.

Keep good records: Track your overtime hours, tip income, and commuter benefits throughout the year. The more organized you are, the easier tax time will be.

Quick Reference: What’s Changed

A Note About FLSA Overtime Rules

For context, the Fair Labor Standards Act requires employers to pay nonexempt employees 1.5 times their regular rate for hours worked over 40 in a workweek. Exempt employees (those in executive, administrative, or professional roles meeting certain salary and duties tests) are not entitled to overtime. In California, state overtime rules may provide additional protections beyond the federal requirements.

This information is effective as of January 10, 2026. Rules and guidelines are subject to change. If you have questions about how these changes affect your specific situation, please contact our office.

Questions? We’re here to help you navigate these changes and make sure you’re taking advantage of every deduction you’re entitled to. Reach out to your Linkenheimer team anytime.