The One, Big, Beautiful Bill (OBBB) made sweeping tax law changes that offer opportunity and present complexity for service industry businesses. The changes include entirely new code sections that create deductions for tip income and overtime pay, along with corresponding reporting obligations on employers. The OBBB also strengthens existing law in ways that make depreciation far more valuable and that led some businesses to reconsider their entity choices. Finally, the new law reimagined some important technical rules regarding interest expense and research costs in ways that make the details even more impactful to many businesses.
We explore significant OBBB changes, with an emphasis on tax-planning insights for leaders in the service sector as they prepare for year-end.
New deductions for tips and overtime pay
President Trump during his 2024 campaign promised to eliminate taxes on tips and on overtime pay. The OBBB delivered on these campaign promises in the form of two new code sections that create deductions, rather than exclusions, for “qualified tips” and for overtime. Both deductions are effectively “above the line” and are available to itemizers and non-itemizers alike.
For businesses where tipping and overtime are prevalent, such as in the hospitality and restaurant sectors, the new deductions alleviate tax burdens on employees who receive income from tips and overtime pay.
Deduction for tip income
Tipped workers, including both employees and independent contractors, can deduct up to $25,000 in qualified tip income from their taxable income. The deduction phases out for single taxpayers with modified adjusted gross income over $150,000 ($300,000 for joint filers). For tips to qualify for the deduction, they must be:
- Cash tips received from customers, though these include tips paid in cash, charged, or paid under a tip-sharing arrangement.
- Paid voluntarily and determined by the payor, without consequence for nonpayment.
- Received by an individual in an occupation that, before 2025, “customarily and regularly” received tips.
- Relate to a trade or business that’s not a specified service trade or business (SSTB) (e.g., accounting, law, medicine, and consulting).
Employers must continue to withhold and remit all Social Security and Medicare taxes (FICA) on all reported tips, as well as their matching employer portion. These tips also remain subject to the Federal Unemployment Tax Act.
Timing and transition rules: The OBBB made the deduction retroactive and temporary; it’s available from Jan. 1, 2025, through Dec. 31, 2028.
- 2025 forms: For the 2025 tax year, Forms W-2, 1099-MISC, 1099-NEC, and 1099-K will not be updated. Expect the forms to be updated for the 2026 tax year and beyond, so employers will need to update payroll systems to separately track “qualified tips” and, beginning for 2026, report this information using new codes. But, for 2025, there’s no need to separately account for tips.
- SSTBs: The last requirement above — that the tips not relate to a SSTB — may be familiar to businesses not organized as C corporations. The qualified business income deduction (QBID) at Section 199A is limited as to SSTBs. The term SSTB means the same thing in the context of the new tip deduction as it does for Section 199A purposes. But because many businesses, especially small businesses, may never have had to determine whether they are a SSTB and will now have to deal with tip income reporting, the IRS is planning on issuing final regulations to help businesses make the determination. Until January 1, after the IRS issues those final regulations, the IRS will look past the SSTB statutory requirement and treat employees as having received tips if the employee worked in an occupation that customarily and regularly received tips on or before Dec. 31, 2024.
Deduction for overtime pay
The OBBB delivered on the president’s campaign promise related to overtime pay in a similar way, by providing a new deduction, rather than an exclusion. The deduction for overtime pay operates in the same way as the tip deduction in that it’s subject to a cap and phases out. The maximum deduction is equal to $12,500 per year for individuals ($25,000 for joint filers) for qualified overtime compensation — the extra 50% pay for hours worked beyond 40 per week, as defined by reference to the Fair Labor Standards Act (FLSA). The deduction also phases out for single filers with modified adjusted gross income over $150,000. Individuals must be FLSA-eligible employees.
Timing and transition rules: The deduction for overtime pay is retroactive back to Jan. 1, 2025, and will be in place through Dec. 31, 2028. There are also transition rules for employers. Employers need not separately account for overtime pay for the 2025 tax year and, to the extent employers don’t, employees must make a reasonable effort to comply. The IRS has set out methods for doing so in some recent guidance.
For additional information, refer to our article, “Restaurants prepare as OBBB initiates no tax on tips, no tax on overtime.”
Section 1202 changes and opportunity
Section 1202, often overshadowed in tax discussions, is now front and center thanks to how the OBBB enhanced it. This section pertains to capital gains exclusions on the sale of qualified small business stock (QSBS) and underscores the importance of determining whether a business operates within a qualifying industry. (For a list of excluded industries, refer to our article, “Almost too good to be true: The Section 1202 qualified small business stock gain exclusion.”)
The alterations expand the scope for gain exclusions, presenting a vital avenue for tax savings. Under previous law, shareholders had to hold QSBS for at least five years in order to qualify for the gain exclusion. The OBBB softened that requirement significantly, such that shareholders only need to hold QSBS for three years to qualify for a 50% gain exclusion, and only need to hold QSBS for four years to benefit from a 75% exclusion. The new law also increased the amount of the exclusion. Under previous law, the exclusion amount was the greater of $10 million or 10 times the aggregate basis of the stock as sold. The OBBB increased the $10 million to $15 million, and kept the alternative way of figuring the exclusion.
Timing: The OBBB’s changes are effective for stock issued after July 5, 2025.
For entrepreneurs contemplating exit strategies, leveraging gain exclusion under Section 1202 could substantially reduce capital gains taxes. Business leaders should consider the viability of converting operations to a qualified small business to maximize this benefit, especially as they plot strategic exits or diversifications. Read our articles, “Expanding the gain exclusion benefit for QSBS: OBBB’s impact on Section 1202” and “Taking it home: Strategic Section 1202 exit planning.”
100% bonus depreciation reinstatement
Another pivotal change made by OBBB is the return of 100% bonus depreciation, which provides an opportunity for businesses to currently deduct the total cost of eligible depreciable assets acquired and placed in service after Jan. 19, 2025. Without the OBBB, bonus depreciation would have phased down to 40% for the current year.
The reinstatement of bonus depreciation to 100% is expected to drive increased capital investment, as higher capital expenditures can now even more significantly reduce immediate tax liabilities. If your business is investing in substantial property or equipment, this provision could lead to considerable tax savings. It’s advisable to strategize around asset acquisition to leverage this depreciation during tax planning for businesses. Focus on timing your purchases to maximize deductions within the desired tax year.
Timing: As noted, the 100% deduction is retroactive to property acquired after and placed in service after Jan. 19, 2025. The OBBB made the 100% deduction permanent. Property may, for purposes of the deduction, be acquired by written binding contract. There are nuanced rules surrounding whether there’s a written binding contract, and, if there was, when property was acquired under it. Placed in service means that the property is ready and available for use in a trade or business.
For more information, read our article, “100% bonus depreciation returns with the One, Big, Beautiful Bill.”
QBID
The OBBB extends the 20% QBID, noted above, on a permanent basis while extending the range of income over which the phaseouts occur. It also creates a minimum deduction of $400 for certain taxpayers with active business income.
Timing: The phase-in income thresholds and minimum deduction apply beginning in the 2026 tax year.
For further background to the QBID and its relationship to specified service trades or businesses refer to our previous article and associated tax alert, “10 things you need to know now about the final qualified business income deduction (QBID) regulations.”
Interest expense limitation under Section 163(j)
The OBBB restores the interest expense limitation under Section 163(j) to its initial form. Since 2022, and until the OBBB took effect, the limitation had been calculated after allowing deductions for depreciation, amortization, and depletion. The limitation’s previous form reduced adjusted taxable income, the base upon which the limit is applied, thereby reducing annual business interest expense deductions for many taxpayers. The OBBB restores the addbacks for depreciation, amortization, and depletion deductions, including an addback for the write-off of previously capitalized Section 174 deductions, as noted above.
Timing: The modifications that restore Section 163(j) to its pre-2022 “EBITDA” form are effective retroactively, beginning Jan. 1, 2025. Beginning in 2026, the new law will require the interest expense limitation to be calculated before any elective capitalization is done under Section 263(a), by way of the election at Section 266.
Research and development (R&D) expenditures under Section 174
The OBBB reinstates the immediate deductions for all domestic research and experimental expenses. This is a change from previous law, which required a five-year amortization period for such expenses. Foreign costs are excluded from the OBBB changes and will continue to be amortized over 15 years.
Timing and transition rules: Immediate expensing of domestic R&D costs was made retroactive to Jan. 1, 2025. The OBBB created two new transition rules. One applies to all taxpayers and allows any remaining domestic R&D costs capitalized in 2022, 2023, or 2024 to be deducted immediately in 2025, or else spread evenly between 2025 and 2026. A second transition allows small taxpayers (under $31 million in gross receipts) to amend their 2022, 2023, and 2024 returns to remove capitalized R&D costs. The OBBB also made certain changes to the research credit at Section 41, which are effective retroactively beginning Jan. 1, 2025.
Service businesses need to evaluate impacts on taxable income and explore opportunities to mitigate these limitations and exploit tax-savings opportunities within the service industry framework. For more information, read our article, “One, Big, Beautiful Bill restores expensing of domestic Section 174 R&E costs.” For additional information on the two transition rules, see our article, “Section 174 guidance clarifies time-sensitive 2024 R&E deduction opportunities for small taxpayers.”
IRS scrutiny on ERC claims
The employee retention credit (ERC) was introduced as a relief measure during the COVID-19 pandemic, and because of some issues with fraud and abuse, the credits have been an enforcement area of focus for the IRS in the last few years.
The OBBB extends the statute of limitations for ERC enforcement to six years, with the six-year period beginning on the later of the date on which the original return was filed, or the date on which the ERC claim was filed. The new law also disallows certain ERC claims made after Jan. 31, 2024.
Businesses claiming the ERC should maintain detailed documentation to support their position and review prior claims to confirm accuracy and compliance. These steps are essential to mitigate potential liabilities and ensure adherence to current regulations. For more information, read our article, “How the One, Big, Beautiful Bill impacts the ERC.”
Tax-planning opportunities
To fully capitalize on these changes, service industry leaders should consider the following proactive strategies:
- Maximize depreciation and interest deductions. Evaluate potential for increased deductions by capitalizing repair and maintenance expenditures to fixed assets to both maximize depreciation and interest deductions under the revised 163(j) rules.
- Communicate tax nuances to employees. Ensure staff affected by the “no tax on tips and overtime” provisions are fully informed. Strategic communication can not only foster transparency but also enhance workforce morale.
- Establish a well-developed ERC strategy. Conduct thorough reviews of existing ERC claims, preparing comprehensive evidence to support large claims amid increased IRS scrutiny. Proactivity here could safeguard against financial penalties down the line.
- Assess exit planning. Carefully consider the benefits of converting to a C corporation under Section 1202 for gain exclusion purposes. Analyze how this aligns with long-term business goals and potential tax benefits.
By taking deliberate action on these opportunities, you can position your organization to thrive under the new tax framework.
The implications of the 2025 tax changes under OBBB are vast and multifaceted, offering service industry businesses a spectrum of opportunities and challenges. Navigating these changes with the right insights can ensure maximized tax benefits and strategic alignment with your business objectives. Ultimately, your organization will be equipped to continue driving your business toward greater success and sustainability in the years to come.
