The One Big Beautiful Bill Act: What SMBs need to know about payroll and time tracking changes

On July 4, 2025, President Trump signed the One Big Beautiful Bill Act into law, marking the most significant change to payroll and tax compliance for small and medium businesses since 2017. 

The bottom line: businesses with tipped or overtime employees need to update their payroll systems immediately, while all SMBs should prepare for new compliance requirements that could save thousands in taxes—if implemented correctly.

This comprehensive legislation permanently extends the Tax Cuts and Jobs Act while introducing new deductions that directly impact how you track time, process payroll, and report employee compensation. 

The changes are retroactive to January 1, 2025, meaning your business needs to act now to capture benefits and avoid compliance issues.

What changed and why it matters for your business

The One Big Beautiful Bill Act, or OBBBA, introduces two game-changing provisions for SMBs: the “no tax on tips” and “no tax on overtime” deductions. These aren’t just tax benefits—they’re compliance requirements that fundamentally change how you track and report employee compensation.

Here’s what’s immediately different: employees can now deduct up to $25,000 in qualified tips and up to $12,500 in qualified overtime premium from their federal income taxes through 2028. But here’s the catch—your payroll system must separately track and report these amounts, and only specific types of tips and overtime qualify. Employers will still withhold federal income tax, social security and Medicare taxes. Employees are responsible for deducting the amount on their individual tax returns.

The legislation also makes permanent several business-friendly provisions that were set to expire, including the 20% qualified business income deduction and enhanced depreciation rules. For SMBs, this creates both opportunities and obligations that require immediate attention.

Federal requirements: New payroll tracking obligations

Tips tracking gets specific

The tips deduction only applies to employees in occupations that “customarily and regularly” received tips before December 31, 2024. The IRS must publish this official list by October 2, 2025, but restaurants, bars, salons, and similar service businesses should prepare now.

What qualifies as tips under the new law:

• Cash tips directly from customers
• Credit card tips processed through your payment system
• Tips voluntarily given by customers without negotiation

What doesn’t qualify:

• Mandatory service charges (like auto-gratuity on large parties)
• Fees you add to bills and distribute to employees
• Non-cash tips or gifts

Your payroll system must track qualified tips separately and report them in a new section of Form W-2. For 2025, the IRS allows any “reasonable method” to estimate qualified tip amounts, giving you flexibility during this transition year.

Overtime tracking becomes more complex

The overtime deduction only applies to the “premium” portion of FLSA-required overtime—essentially the “half” in time-and-a-half. This creates a critical distinction: state-mandated overtime, union-negotiated overtime, and voluntary overtime policies don’t qualify.

Here’s where time tracking software becomes crucial. Your system needs to differentiate between:

• FLSA-required overtime (eligible for deduction)
• State law overtime requirements (not eligible)
• Collective bargaining agreement overtime (not eligible)
• Daily overtime vs. weekly overtime calculations

Example:

For a restaurant manager earning $15/hour working 50 hours: the first 40 hours at $15/hour plus 10 hours at $22.50/hour ($15 × 1.5) means the qualifying deduction amount is only $75 (10 hours × $7.50 premium).

New W-2 reporting requirements

Starting with 2025 W-2s (issued in early 2026), you’ll need separate reporting for:

• Qualified tip amounts (likely in Box 12 or Box 14)
• Qualified overtime premium amounts
• Proper classification to ensure employees can claim deductions

State-level complications: Why location matters

While the tips and overtime deductions only apply to federal income tax, state tax treatment varies dramatically. Most states haven’t updated their tax codes to conform with the federal changes, creating a compliance patchwork that particularly challenges multi-state businesses.

State conformity creates complexity

States fall into three categories:

• Automatic conformity states like Colorado and Oregon immediately incorporate federal changes, potentially creating state revenue losses
• Rolling conformity states automatically adopt certain provisions but may exclude others
• Fixed-date conformity states like Arizona won’t incorporate changes until their legislatures act

For businesses operating across state lines, this means your payroll system needs to handle federal qualified tips and overtime while maintaining separate tracking for state tax purposes.

SALT deduction opportunities

The legislation increases the state and local tax (SALT) deduction cap from $10,000 to $40,000 through 2029, with income-based phase-outs starting at $500,000 for individuals. This particularly benefits SMB owners in high-tax states like California, New York, and New Jersey who previously hit the $10,000 cap.

However, the interaction between federal and state tax systems creates planning opportunities that require professional guidance. A restaurant owner in New York earning $200,000 could see significant tax savings from both the increased SALT deduction and qualified tips/overtime provisions—if properly coordinated.

Technology implications: What your software needs to do

The legislation essentially requires a complete upgrade of how payroll and time tracking systems handle compensation data. If your current software can’t distinguish between FLSA overtime and state-mandated overtime, you’re already behind.

Essential software capabilities

Your payroll system must now handle:

• Separate overtime calculations for FLSA vs. state requirements
• Tip qualification verification against the IRS occupation list (due October 2)
• Premium pay isolation from total overtime compensation
• Enhanced W-2 reporting with new deduction-eligible amount categories
• Retroactive processing for 2025 data when implementing mid-year

Leading providers are taking different approaches. Gusto is emphasizing accuracy guarantees and integration with tax preparation software. ADP is leveraging existing compliance infrastructure for faster implementation. Paylocity is focusing on real-time compliance alerts and enhanced reporting.

Questions to ask your payroll provider

Before committing to any payroll software, ask:

1. “How do you separate FLSA-required overtime from state-mandated or voluntary overtime?”
2. “Can your system retroactively process 2025 data for the new reporting requirements?”
3. “What’s included in your standard service level for One Big Beautiful Bill Act compliance?”
4. “How do you handle multi-state businesses with different overtime laws?”
5. “What training and ongoing support do you provide for the new requirements?”

Integration challenges and solutions

The biggest technical challenge is connecting time tracking with payroll processing. Your time clock system needs to:

• Accurately classify overtime as FLSA vs. non-FLSA
• Track break compliance to ensure proper overtime calculations
• Handle geolocation data for multi-state compliance
• Integrate seamlessly with payroll for qualified amount reporting

Many businesses are discovering their current time tracking and payroll systems don’t “talk” to each other effectively. This is the time to evaluate whether separate systems make sense or if an integrated solution better serves your compliance needs.

Implementation timeline: Critical dates for your calendar

Immediate actions

By August 31: Audit your current payroll and time tracking capabilities. Document all tipped and overtime employees and assess whether your systems can handle the new requirements.

By September 15: Engage with your payroll software provider about upgrade timelines and compliance features. If switching providers, start the transition process immediately.

October 2: The IRS publishes the official list of customarily tipped occupations. Verify your employees’ eligibility and update payroll classifications.

Year-end preparation (October-December 2025)

November-December: Implement new payroll system features and train staff on updated procedures. Use the IRS’s “reasonable method” flexibility to establish tracking for qualified tips and overtime.

December 31: Last chance to make equipment purchases eligible for enhanced Section 179 expensing (increased from $1.25 million to $2.5 million) and restored 100% bonus depreciation.

Ongoing compliance (2026 and beyond)

2026 tax season: First W-2s with separate tip and overtime reporting. Ensure employees understand how to claim new deductions on their tax returns.

2028: Most temporary provisions expire, requiring another system adjustment to remove tip and overtime deduction tracking.

Beyond payroll: Other SMB opportunities

While payroll changes grab immediate attention, the legislation offers additional benefits worth considering:

Business tax advantages

The Section 199A qualified business income deduction is now permanent at 20%, providing significant tax savings for pass-through entities. Combined with the tip and overtime provisions, restaurants and service businesses could see substantial overall tax reductions.

Enhanced depreciation rules allow immediate expensing of equipment purchases up to $2.5 million (up from $1.25 million) plus 100% bonus depreciation for assets placed in service after January 19, 2025.

Qualified Small Business Stock benefits

The legislation dramatically improves QSBS benefits for small business investments:

• Holding period reduced from 5 to 3 years
• Asset threshold increased to $75 million
• Gain exclusion increased to $25 million per taxpayer

For SMBs considering C-corp conversion or seeking investment, these changes create significant planning opportunities.

When to seek professional help

Engage a tax professional immediately if you have:

• Annual revenue exceeding $5 million
• Tipped employees in multiple states
• Complex overtime policies or union contracts
• Plans for major equipment purchases or facility expansion
• Questions about entity structure optimization

You might handle initial compliance in-house if you have:

• Simple business structure with straightforward payroll
• Single-state operations with few employees
• Reliable payroll software with confirmed compliance features
• Strong internal accounting and HR capabilities

However, even smaller businesses should consider professional consultation for year-end tax planning. The interaction between tip/overtime deductions, enhanced business provisions, and state tax implications creates complexity that warrants expert guidance.

Practical next steps for SMB owners

This summer:

1. Contact your payroll provider about One Big Beautiful Bill Act compliance timelines
2. Document all current tipped and overtime employees for system updates
3. Review your 2025 equipment purchase plans for depreciation benefits

By September 30:

1. Upgrade or replace payroll systems that can’t handle new requirements
2. Train managers on distinguishing between FLSA and state overtime
3. Establish procedures for tracking qualified tips and overtime

By December 31:

1. Implement full compliance procedures for tip and overtime tracking
2. Execute any planned equipment purchases for enhanced depreciation benefits
3. Prepare for 2026 tax season with updated W-2 reporting capabilities

Getting compliance right

The One Big Beautiful Bill Act represents both significant opportunity and compliance obligation for SMBs. The businesses that act quickly to update their systems and processes will capture substantial tax benefits while avoiding compliance issues. Those who wait risk missing deductions, facing penalties, or discovering their software can’t handle the requirements.

Remember, this legislation includes temporary provisions expiring in 2028, permanent changes affecting long-term planning, and complex interactions with state tax systems. Professional guidance isn’t just recommended—for most businesses beyond the simplest structures, it’s essential for maximizing benefits while maintaining compliance.

The key to success lies in treating this as a business process change, not just a tax law update. Your payroll and time tracking systems are now compliance tools that directly impact your employees’ tax situations and your business’s reporting obligations.

Disclaimer: This article provides general information about the One Big Beautiful Bill Act and should not be considered tax or legal advice. The legislation is complex, and implementation requirements may change as federal agencies issue additional guidance. Always consult with qualified tax professionals and employment law attorneys for advice specific to your business situation. Requirements may vary by state, and businesses operating in multiple jurisdictions face additional complexity requiring professional guidance.