Certain Payroll Withholdings Rise to Reflect Inflation 

Year-end is a busy and challenging time for most businesses, and this year promises to be a bit more complicated as finance and human resources departments implement compliance with provisions of the “One Big Beautiful Bill” (OBBB) tax law enacted in July 2025. 

Specifically, the provisions affecting taxation of overtime pay and tip income will impose new reporting requirements on businesses and individual taxpayers. 

To comply with the law, businesses must provide documentation on workers’ Forms W-2 or 1099 specifying the amounts of overtime pay and tip income they received. The IRS has not provided a form or definitive guidance on how to do this, but has released a notice that it will provide relief — for the 2025 tax year only — from penalties for failure to file correct information returns and for failure to furnish correct payee statements. The notice further states that guidance for individual taxpayers on how to claim the deductions for overtime and tip income is forthcoming. 

Payroll providers generally agree that Box 14 on the W-2 is the most logical option for including the overtime and tip information, but while some payroll software providers have said they will use Box 14, others have not yet stated what they will do. 

Background 

During the 2024 presidential campaign, President Trump promised workers that taxation of overtime and tip income would end. That promise was modified when the OBBB was put together. Instead of ending taxation, the law provides a partial deduction against overtime and tip income. This deduction is temporary, available for tax years 2025 through 2028. 

Points that are important for employers and employees to keep in mind in relation to these new tax deductions: 

  • Restaurants must distinguish between “tip” income and “gratuity or service charge” when reporting this income to the IRS. A tip is voluntarily given by a customer. A gratuity or service charge is a separate charge on the bill that is often added for large parties in a restaurant, and it is a required payment. The deduction may only be claimed against voluntary tip income. 
  • The deduction for overtime pay applies only to the portion of pay that is above the worker’s ordinary wages. For instance, if a worker makes $10 per hour and their overtime pay is $15 per hour, the deduction can only be applied against $5 of the overtime pay since that is the amount above the worker’s ordinary pay. 

If you have questions about how to provide the correct overtime and tip income information to employees during tax season, contact your payroll provider or your Adams Brown Payroll Services advisor. 

Following is a checklist of items to accomplish before the end of the year: 

2026 Payroll Changes  

  • Social Security wage base: The wage base for 2026 is $184,500, with a 6.2% match from both employee and employer. The maximum deduction will be $11,439. 
  • Medicare tax: No limit to wages subject to the 1.45% Medicare Tax. Wages above $200,000 (single) or $250,000 (married filing jointly) will incur an additional 0.9% tax. This remains unchanged from 2025. 
  • Dependent Care Limits: The maximum exclusion is $7,500 for individuals or married couples filing jointly. This is a 50% increase over the 2025 level. For married taxpayers filing separately, the exclusion rises to $3,750, also a 50% increase. 
  • Health Flexible Spending Arrangements (FSA): The 2026 employee salary reduction contribution limit is $3,400. 
  • Health Savings Accounts (HSAs): Maximum contributions are $4,400 for individuals and $8,750 for families. Individuals 55 and older can make an additional $1,000 catch-up contribution. 
  • IRA contribution limits: $17,000 for Simple IRAs. Individuals aged 50 and over are allowed a 4,000 catch-up contribution. For certain plans, individuals aged 60 to 63 in 2026 are allowed a catch-up contribution of $5,250. 
  • 401(k), 403(b) and 457 contribution limits: The employee deferral limit is $24,500, with an $8,000 catch-up contribution for those 50 or older. 

Before Dec. 31  

  • Verify company information: Ensure all company details, including tax IDs and email addresses, are up to date. 
  • Verify W-2 delivery addresses: Make sure the addresses for sending out W-2 forms are correct. 
  • Process bonus payrolls: Handle any end-of-year bonuses separately for clarity. Make sure you have communicated the data concerning year-end bonuses to the payroll provider, and that it has been recorded properly to ensure it is reported in the current period. 
  • Run the last payroll for the year: A significant step to close the books on the current year. 
  • Review Social Security records: Ensure any name changes or address changes have been made. 
  • Order forms & envelopes for W-2/1099 processing: Stock up on necessary supplies to avoid last-minute rushes. 

Communicate Year-end Payroll Add-Backs to Payroll Provider 

  • S-corp owners’ health, dental and accident insurance premiums for addition to W-2 
  • Calculated value of personal use of company car 
  • Commodity wages for farmers 
  • Third-party sick pay 

Before Your First Payroll in January   

  • Adjust PTO accrual balances: Align with your company policy and update as necessary. 
  • Update employee information: Reflect pay rates and deductions, as well as changes in names and addresses, effective Jan. 1. 
  • Communicate changes in benefits: Communicate changes in benefits to your payroll provider as far in advance as possible before the first payroll. 
  • Obtain new W-4 forms (if necessary): Ensure compliance with the latest tax withholding requirements. 
  • Review ACA requirements: Stay informed about any changes or updates. 
  • Review state minimum wage changes: Adjust payroll systems to reflect any state-specific minimum wage increases. 
  • Review state unemployment insurance changes: Update your records to reflect any rate changes or new regulations. 
  • Review payroll software to ensure it is updated: If you do payroll internally, ensure your payroll software is updated with the latest wage and withholding requirements. 

January 

  • Receive & review year-end Forms W-2 and 1099: Check for accuracy if an outside provider prepares these. If done in-house, ensure they are ready for distribution. If you have questions regarding who should get a W-2, click to learn more. 
  • Reconcile W-3 with quarterly 941s or annual 944: A critical step for accurate tax reporting. 

Before February 2
(January 31 falls on a Saturday in 2026)  

  • File 1099s with the IRS: Timely filing is crucial to avoid penalties. 
  • File W-2s with the Social Security Administration: Ensure all employee information is reported accurately. 
  • Distribute W-2s and 1099s to employees & contractors: This is a legal requirement and must be done timely. Encourage employees to carefully review their W-2s for accuracy and inform you of any necessary changes immediately. 
  • File Form 940: Report your annual Federal Unemployment Tax Act tax. 
  • File Form 941 or 944: These are your quarterly or annual payroll tax returns. 
  • E-filing of W-2 and 1099s: If you send out more than 10 W-2 or 1099 forms, you are required to file them electronically. 

Remember: If a deadline falls on a weekend, the returns or forms are due the next business day.  

Completing these tasks may feel overwhelming, but they are important for a smooth transition into the new year. Consider setting reminders for each task and delegating where possible. Your attention to these details keeps your business running smoothly. 

It shows your employees and contractors that you value their contributions and are committed to accuracy and timeliness in all aspects of your business operations. If you would like to discuss payroll outsourcing, contact an Adams Brown advisor.