New IRS guidance on tips and overtime deductions for 2025

Tax year 2025 marks the first time many American workers can take federal income tax deductions for qualified tips and qualified overtime compensation. These valuable new deductions were created by the One Big Beautiful Bill Act (OBBBA), and the IRS has now issued Notice 2025-69 to walk taxpayers through the rules for this inaugural year. 

The guidance aims to bridge the gap between the law’s new requirements and the reality that wage reporting systems will not fully catch up until 2026. For tax professionals, the notice offers the framework needed to support clients during this transition. For everyday workers who rely on tips and overtime, it explains how to calculate these deductions, even though 2025 Forms W-2, Wage and Tax Statement, and 1099-K, Payment Card and Third Party Network Transactions, will not yet include separate reporting boxes for these amounts.

Deduction for qualified tips §224

The first deduction covers “qualified tips,” defined as voluntary cash or charged tips received in an occupation that customarily and regularly received them on or before Dec. 31, 2024. 

• Deduction limit: The deduction is capped at $25,000 per year. It is subject to a phase-out for taxpayers with a modified adjusted gross income (MAGI) over $150,000 ($300,000 for joint filers).
• Calculating the deduction (employees): Since 2025 Forms W-2 will not be updated, the IRS permits employees to determine their qualified tips using one or more of the following, based on their records:
  
  • The amount of Social Security tips shown in Box 7 of Form W-2
  • The total tips reported to the employer on all Forms 4070, Employee’s Report of Tips to Employer
  • Any amount the employer voluntarily reports in Box 14 of Form W-2 or a separate statement
  • Any unreported tips included on Line 4 of Form 4137, Social Security and Medicare Tax on Unreported Tip Income 

Calculating the deduction

Independent contractors and other self-employed individuals will not see tips broken out on their 2025 Forms 1099-NEC, Nonemployee Compensation, 1099-MISC, Miscellaneous Information, or 1099-K. They must rely on their own documentation, such as daily tip logs, point-of-sale reports or third-party settlement records, to substantiate the amount of tips received. 

Important transition relief

The law excludes tips received in a "specified service trade or business" (SSTB). However, determining an employer's SSTB status can be a complex process. For 2025, the IRS is providing transition relief. The agency will not challenge a taxpayer's claim that their tips are eligible, provided the taxpayer works in an occupation that was on the IRS's published list of customarily tipped occupations as of the end of 2024. This relief gives workers and tax professionals the certainty they need to make reasonable determinations. 

Deduction for qualified overtime compensation

The second deduction applies to “qualified overtime compensation.” This is narrowly defined as only the premium portion of overtime pay that is required under the federal Fair Labor Standards Act (FLSA). Typically, the “half” in “time-and-a-half” pay for hours worked over 40 in a workweek. Overtime paid solely due to state law, a union contract or employer policy that exceeds FLSA requirements does not qualify. 

• Deduction limit: The deduction is capped at $12,500 per year ($25,000 for joint filers). It is subject to the same modified adjusted gross income (MAGI) phase-out as the tip deduction ($150,000 single / $300,000 joint).
• Calculating the deduction: Again, 2025 information returns will not separately state this amount. The notice provides several "reasonable methods" for taxpayers to calculate their deduction using pay stubs or annual payroll summaries:
  
  • If the FLSA premium is separately stated: Use that amount.
  • If total “time-and-a-half” overtime is shown: The deductible portion is one-third of the total overtime amount shown on the pay statement.
  • If the total “double-time” overtime is shown: The deductible portion is one-fourth of the total overtime amount. 

Notice 2025-69 also provides examples for more complex situations, such as compensatory time for government employees and special work period rules for law enforcement, helping taxpayers in various industries calculate their deduction.  

Key rules for both deductions

• Recordkeeping is essential: The IRS stresses that workers must retain pay stubs, tip logs, payroll reports, and any other employer statements that support both their eligibility for the deductions and the amounts claimed.
• Above-the-line deductions: Both deductions are available to all eligible taxpayers, whether they itemize or take the standard deduction.
• Married filing jointly: To claim either deduction, married taxpayers must file a joint return.
• No penalties for employers: The IRS has also provided penalty relief for employers and payors who do not comply with the new reporting requirements for the 2025 tax year, acknowledging this transition period. 

Looking ahead

The 2025 filing season will require more careful attention than usual for tipped and overtime workers; however, IRS Notice 2025-69 provides the necessary tools and flexibility to navigate these changes. The key is clear: keep thorough records, rely on the reasonable methods outlined in the notice, and prepare for a filing season that rewards the long hours and hard-earned income of America’s workers.