IRS provides guidance for individuals to claim ‘no tax on tips and overtime’ deductions for 2025

Background

The One Big Beautiful Bill (OBBBA), enacted in July 2025, introduced two new above-the-line deductions for individuals, effective for tax years 2025 through 2028:

• A deduction for qualified tips, up to $25,000 per year.
• A deduction for qualified overtime compensation, up to $12,500 per year ($25,000 for joint filers).

Both deductions are subject to phase-out based on modified adjusted gross income (MAGI).

The law requires the deductible amounts to be separately reported on information returns furnished to individual taxpayers along with other information about their occupation for tips-deduction claimants. However, as noted, the IRS has delayed this reporting requirement for employers and other payors until the 2026 tax year. Notice 2025-69 helps to facilitate uptake of these new benefits for 2025 by providing alternative methods for individuals to determine and substantiate their tip and overtime deductions.

In September of 2025, the IRS released proposed regulations detailing certain proposed rules related to qualified tips, including the definition of qualified tips, which tips would qualify for the deduction and SSTB rules with a request for comments on the application of those rules specifically. See our article on the proposed regulations for more details.

Guidance for the Qualified Tip Deduction

For 2025, since Forms W-2, 1099-NEC, 1099-MISC and 1099-K will not have a dedicated box for qualified tips or tipped occupation codes, the notice provides several ways for taxpayers to calculate the amount of their deductible tips. Employees are still responsible for determining whether the tips received were received in an occupation that customarily and regularly received tips on or before Dec. 31, 2024, as is required under the law. The instructions to the 2025 Form 1040 will provide more information on making this determination. Some employers may choose to provide information on an employee’s occupation or other relevant information to employees by a separate statement or using box 14 of Form W-2, in which case employees may rely on that information. Employees may determine their qualified tip amount using:

1. The total social security tips reported in box 7 of Form W-2;
2. The total tips reported by an employee to their employer on Form 4070, Employee’s Report of Tips to Employer; or
3. An amount voluntarily reported by an employer in box 14 of Form W-2.

Additionally, any unreported tips included in income on Form 4137, Social Security and Medicare Tax on Unreported Tip Income, can be added to the above.

Nonemployees (e.g., independent contractors) who receive tips must rely on their own records to determine the deductible amount. The notice allows them to use earnings statements, point-of-sale reports, daily tip logs or other documentary evidence to calculate the portion of their gross receipts (reported on Forms 1099) that constitutes qualified tips.

SSTB Transition Relief: Qualified tips generally do not include those received in the course of working for an SSTB. The notice indicates that additional guidance is needed to assist employees and employers in determining whether an employer’s trade or business is an SSTB, and that they will also need additional time once guidance is issued to understand and implement the guidance. As a result, in the notice, the IRS provides a transition period for purposes of IRS enforcement and administration with regard to the SSTB requirement.Specifically, until Jan. 1 of the first calendar year following the issuance of final regulations regarding the SSTB requirement, the IRS will treat employees as having received tips in the course of a trade or business that is not a SSTB if the employee’s occupation would otherwise qualify them for the deduction. This effectively waives the SSTB restriction for 2025, simplifying eligibility for many taxpayers. The IRS anticipates issuing additional proposed regulations on the SSTB rules.

Guidance for the Qualified Overtime Deduction

The notice clarifies that qualified overtime compensation is pay that is required under the Fair Labor Standards Act (FLSA). This is generally the premium of 1.5 times the regular rate of pay for hours worked over 40 in a workweek (also known as ‘time and a half’). Overtime paid for other reasons, such as under a collective bargaining agreement or state law, that is not required by the FLSA, does not qualify.

The notice instructs taxpayers to first make a reasonable effort to determine if they are an ‘FLSA-eligible employee.’ If so, and if their employer does not voluntarily report the qualified overtime amount on a separate statement or on a Form W-2, taxpayers can use other documentation, such as pay stubs or earnings statements, to calculate the deduction using one of the ‘reasonable methods’ provided in the notice. Examples of these methods include:

• If a pay statement for 2025 separately identifies the ‘overtime premium’ (the ‘half’ portion of time-and-a-half), the taxpayer may use that amount.
• If a pay statement shows a total ‘overtime’ amount that includes both the regular rate and the premium for overtime hours, the taxpayer may use one-third of that total amount as the qualified deduction.
• The notice describes the use of fractional multipliers for calculating the FLSA-required premium when an employer pays a higher rate, such as double time. For example, if an employer pays double time (an extra full hour of pay as premium) and the pay stub shows the total overtime amount (regular pay plus premium), the taxpayer would multiply the total by 25% to determine the qualified amount (the ‘half-time’ premium required by the FLSA).

If certain methodologies described in the notice would result in underestimating the employee’s qualified overtime compensation (for example, because the individual’s regular rate is increased by a nondiscretionary bonus), the individual may adjust the method to take the difference into account. The notice also provides guidance for more complex situations, including employees subject to alternative FLSA overtime rules, such as certain law enforcement and hospital employees.

Recordkeeping and next steps

The notice reminds taxpayers that they must maintain copies of any documents they rely on in accordance with IRS recordkeeping requirements (including, for example, retaining copies of Forms W-2 and 1099, pay stubs, tip logs and any other documentation used to determine eligibility and calculate deductions.)

This guidance provides individuals a way to determine eligibility and to claim new deductions absent full and complete reporting from employers that choose to take advantage of the relief from the reporting requirements for the 2025 tax year. Individual taxpayers should consider carefully reviewing their eligibility, including income phaseout rules and maintaining thorough records if claiming deductions. Employers and payors are required to comply with the information reporting requirements beginning in 2026.