What happened?

As a reminder, the One Big Beautiful Bill Act (OBBBA) created two new federal income tax deductions beginning in 2025: one for qualified tips and one for qualified overtime compensation. These deductions apply to tax years 2025 through 2028.

The Internal Revenue Service (IRS) issued Notice 2025-69 to explain how employees can calculate and claim these deductions for the 2025 tax year. This guidance is necessary because Forms W-2 and 1099 will not include separate reporting fields for qualified tips or qualified overtime until tax year 2026.

Under the IRS guidance:

• Employees may deduct up to $25,000 in qualified tips subject to income-based phase-outs.
• Employees may deduct up to $12,500 in qualified overtime premium ($25,000 for joint filers).

Overview

2025 is a transition year: Forms W‑2 and 1099 will remain unchanged, and employers are not yet required to separately report qualified tips, qualified overtime, or occupation codes. Full separate reporting – including occupation codes – begins in 2026.

During 2025, employees may use the following documentation to calculate and substantiate their deductions:

• Box 7 (Social Security tips), Form 4070, Form 4137, and pay statements.
  The IRS also provides simplified methods to calculate the overtime premium when only total overtime pay is shown:
  
  • Divide total overtime wages by 3 for time and a half hours.
  • Divide total overtime wages by 4 for double time hours.

Additional qualification rules include:

• Tips qualify only if they were earned in an occupation in which tipping was customarily received before December 31, 2024, and they must be voluntary. Tip sharing is allowed, but mandatory service charges, including automatic gratuities added to the bill, do not qualify.

• The overtime deduction covers only the Fair Labor Standards Act (FLSA)-required premium (“the half-time” portion above the regular rate). State-mandated, union-negotiated premiums or straight time “overtime” for exempt employees do not qualify.

• Specified Service Trade or Business (SSTB) Rule Relief (2025): Under normal rules, qualified tips cannot be earned in an SSTB. However, IRS Notice 2025-69 delays this restriction for 2025. Tips received in IRS-listed tipped occupations may still be treated as qualified until final regulations are issued.

Why this matters: Employees can reduce taxable income for the 2025 tax year. Employers must finalize communications, documentation processes, and payroll system updates to comply with the 2026 separate reporting requirements – now in effect – covering qualified tips, qualified overtime, and occupation codes.

Action Steps for Compliance

• Inform employees about qualifications, annual caps, phase‑out rules, and records they must keep.

• Provide year‑end statements and, when feasible, include Box 14 entries (overtime premium) and occupation information to help employees calculate their 2025 deductions.

• Track in payroll:
  • Flag eligible tipped roles and apply correct occupation codes.
  • Separately track the FLSA-required overtime premium (the Section 7 “half-time” amount) versus any other overtime.

• Documentproperly:
  
  • Retain tip logs, Point-of-Sale (POS) reports, Form 4070 and pay stubs.
  • Support self‑employed individuals with third-party settlement organization (TPSO) / Form 1099-K information as applicable.

• Prepare for 2026: Ensure payroll and reporting systems can separately report qualified tips, qualified overtime, and occupation codes on Form W-2 and 1099, as required beginning in the 2026 tax year.

• Add a tax disclaimer: All employee communications should clearly state that the company does not provide tax advice and that employees should consult a qualified tax professional.

Additional Information

Quick overtime math (2025)

• Where an employee pay stub shows a distinct “overtime premium” line, use that amount as the FLSA premium.

• When the pay stub shows a single total overtime amount paid at time‑and‑a‑half (1.5×) and that total combines straight‑time and premium, estimate the FLSA overtime premium as one‑third of that total.

• When the pay stub shows a single total overtime amount paid at double‑time (2.0×) and that total combines straight‑time and premium, estimate the FLSA overtime premium as one‑fourth of that total.

• For public‑sector compensatory time granted at one‑and‑one‑half times, treat one‑third of the comp‑time wages as the FLSA overtime premium component.

Key Risks for Employers

• Misclassification (exempt vs. non‑exempt) leading to incorrect overtime deductions.
• Combining non‑FLSA overtime with FLSA-required premium amounts, resulting in inaccurate calculations.
• Inadequate documentation (tips or overtime) preventing employees from substantiating their deductions.
• Missed 2026 readiness for requirements (occupation codes, separate reporting for qualified tips and overtime).
• Employee confusion without clear guidance and appropriate tax‑advice disclaimers.

For additional details:

• IRS – IR-2025-114 – Press Release (November 21, 2025)
• IRS – Guidance for Individual Taxpayers who received Qualified Tips or Qualified Overtime Compensation in 2025 – Notice 2025-69 

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