On July 4, 2025, the One Big Beautiful Bill Act (OBBBA), Public Law 119-21, was enacted. The OBBBA established several significant tax changes including two new federal income tax deductions for employees: one for qualified tips and one for qualified overtime compensation.
The deductions apply to tax years beginning after December 31, 2024, and ending before January 1, 2029, and taxpayers should anticipate further changes as final regulations are issued after 2025 that may modify the guidance described herein.
Importantly, the IRS has relieved employers and payors from the separate accounting and reporting requirements relative to qualified tips and qualified overtime compensation under the OBBBA for tax year 2025, recognizing that many employers and payors may not have sufficient time and resources to meet the mandate. For more information see IRS Notice 2025-62. Instead, the IRS has issued interim guidance (Notice 2025-62 and Notice 2025-69) to assist employers, payors, and individuals in determining and claiming these deductions for 2025.
General Rules
- Filing status and SSN: To claim either deduction, the individual must include a Social Security Number on their tax return. Married individuals must file jointly to claim the deduction; those filing separately are ineligible.
- Income phase-out: The deductions phase out for taxpayers with MAGI over $150,000 ($300,000 for joint filers).
- Individuals claiming the deductions on their tax returns must maintain copies of any documents they rely on in accordance with IRS recordkeeping requirements.
Qualified Tips — OBBBA Section 70201
- Deduction cap: Up to $25,000 annually.
- Cash-based definition: Tips include cash, credit card tips, and pooled tips. Such amounts must be paid voluntarily without any consequence in the event of nonpayment, are not the subject of negotiation, and are determined by the payor.
- Occupation eligibility (tips): Occupations must have customarily and regularly received tips on or before December 31, 2024, as provided by the Secretary of the Treasury.
- Specified Service Trade or Business (SSTB): Workers in SSTBs (as defined in IRC section 199A(d)(2)) are not eligible, including in fields such as health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investment management, and brokerage/trading/dealing in securities, commodities, or partnership interests. Taxpayers should note that final regulations expected after 2025 may refine or modify this limitation.
- Phase-out: Subject to the general MAGI phase-out above.
Qualified Tips and Occupations Requirements
On September 22, 2025, the Treasury published proposed regulations identifying a list of occupations that customarily and regularly received tips on or before December 31, 2024, and providing a definition of “qualified tips” for purposes of the income tax deduction for qualified tips
The proposed regulations organize qualifying tipped occupations by Treasury Tipped Occupation Codes (TTOC) across eight categories (100s–800s), reflecting occupations such as bartenders, wait staff, entertainers, hotel staff, landscapers, and personal appearance professionals.
The proposed regulations also reiterate and further define “qualified tips” for the purpose of the deduction. Qualified tips must:
- Be paid voluntarily without any consequence in the event of nonpayment
- Not be the subject of negotiation, and
- Be determined by the payor.
The proposed regulations explicitly clarify that service charges, automatic gratuities, and other mandatory amounts automatically added to a customer’s bill by the vendor or establishment, are not qualified tips unless the customer is provided an option to disregard or modify it without consequence.
For example, an automatic 18% charge added to a restaurant bill for parties of six or more is not a qualified tip because the customer cannot modify or disregard it. However, if a recommended 18% tip can be modified by the customer and the customer voluntarily adjusts it to 15%, the 15% is a qualified tip.
Qualified Overtime — OBBBA Section 70202
Scope: Only “qualified overtime compensation” is deductible—overtime compensation required by FLSA section 7 that is in excess of the regular rate; state-mandated overtime beyond FLSA, union-negotiated overtime beyond federal minimums, and voluntary overtime payments are ineligible.
- Deduction cap: Up to $12,500 annually for single filers (or $25,000 for married jointly).
- Phase-out: Subject to the general MAGI phase-out above.
- Only the premium portion counts: Generally, the “half” portion of the “one and one-half times” amount (the FLSA overtime premium).
2025 Implementation Guidance (Notice 2025-69)
On November 21, 2025, the IRS issued Notice 2025-69 to guide individual taxpayers on determining qualified tips and qualified overtime compensation for 2025. Therein, the IRS reiterates that there will be no changes to the 2025 Form W-2, Form 1099-NEC, Form 1099-MISC, or Form 1099-K to account for the new reporting requirements in the OBBBA.
Determining Qualified Tips (2025)
Employees may determine qualified tips for 2025 using:
1. Total social security tips in box 7 of Form W-2.
2. Total tips reported to employer on Forms 4070 (or similar substitute forms).
3. Amount of cash tips voluntarily reported by employer in box 14 of Form W-2 or on a separate statement.
4. Any amount on line 4 of the 2025 Form 4137 filed with the return (and included as income).
Employees remain responsible for determining whether their occupation is eligible.
Examples provided by the IRS that illustrate these methods include:
- Example 1 – Simple W-2 Tips (Server)
- W-2 Box 7 shows $18,000 in tips
- No additional tips reported on Form 4137
- Qualified tips = $18,000
- Example 2 – Multiple Tip Sources (Bartender)
- Reported $20,000 in tips to employer (Form 4070)
- W-2 Box 7 shows $15,000 (wages exceeded social security wage base)
- Form 4137 shows $4,000 in unreported tips
- Two calculation options:
- Option A: $15,000 (Box 7) + $4,000 (Form 4137) = $19,000 qualified tips
- Option B: $20,000 (Form 4070 total) + $4,000 (Form 4137) = $24,000 qualified tips
- Example 3 – Self-Employed with Third-Party Payments (Travel Guide)
- Received $55,000 total on Form 1099-K (includes $7,000 in tips, not separately identified)
- Maintained daily tip logs documenting $7,000 in tips
- Qualified tips = $7,000
Non-employees may determine qualified tips for 2025:
Non-employees (including independent contractors and self-employed individuals) may determine qualified tips for 2025 using Forms 1099-MISC, 1099-NEC, or 1099-K, even if tips are not separately identified. Tips may be calculated using earnings statements, receipts, point-of-sale reports, daily tip logs, third-party settlement organization records, or other documentation that supports the total qualified tip amount. For example, contractors who provide services to a payor may use tip amounts shown on payor-issued earnings statements, provided all other qualified tips requirements are met and records are maintained per IRS requirements.
Determining Qualified Overtime Compensation (2025)
An individual must be covered by and not exempt from the FLSA (FLSA-eligible employee) in order for overtime compensation to qualify for deduction. Positions which are statutorily exempt from the FLSA’s overtime requirements are ineligible for the deduction including bona fide executive, administrative, professional, outside sales, and highly compensated employees. Individuals who are not furnished a separate accounting of qualified overtime compensation in box 14 of Form W-2 (or on a separate statement) must make a reasonable effort to determine whether they are considered FLSA-eligible employees, which may include asking their employers or other service recipients about their status under the FLSA.
The OBBBA also requires separate accounting of qualified overtime compensation. Because 2025 is a transitional year, employers and other payors will not be required to separately account for qualified overtime compensation on relevant tax forms or written statements furnished to individuals for 2025. Accordingly, the IRS has determined that the separate accounting requirement may be satisfied by the following:
- If the amount of qualified overtime compensation is reported using box 14 of Form W-2 or on a separate statement, employees may treat the separate accounting requirement as satisfied and use this amount for purposes of determining the deduction.
- If the amount of qualified overtime compensation is not provided by the employer in box 14 of the Form W-2 or separate statement:
- If the employee’s qualified overtime compensation is included on Forms W-2, or separate statement, (copies of which are furnished to the individual) it may be considered as properly reported, even if it is not separately accounted for as “qualified overtime compensation.”
- An employee may base the determination of the amount of qualified overtime compensation on other documentation such as earnings or pay statements, invoices or similar statements which support the determination using a reasonable method described in the notice.
Reasonable methods for 2025 include:
A. Standard time-and-a-half; premium separately shown. An individual receives a statement covering the entire 2025 tax year that separately accounts for the overtime premium-the “half” portion of “one and one-half times” pay (the FLSA Overtime Premium). Use the separately stated premium for the full 2025 tax year. Example: “$5,000 overtime premium” equals $5,000 qualified overtime compensation.
B. Total overtime shown (combined) at time-and-a-half. Individual receives a statement covering the entire 2025 tax year that does NOT separately show the premium but shows an aggregate “overtime” amount that includes both the premium & regular wages for hours worked over 40. Divide the aggregate overtime amount by 3 for the full 2025 tax year. Example: $15,000 ÷ 3 = $5,000 qualified overtime compensation.
C. Premium separately shown at higher rate (e.g., 2x). Individual is paid overtime at MORE than 1.5x (e.g., 2x regular rate), and the individual receives a statement covering the entire 2025 tax year that shows the separate premium portion above the regular rate. Multiply the separately stated premium by an appropriate fraction to approximate the FLSA premium; for 2x, use one-half. Example: $10,000 × 1/2 = $5,000.
D. Total overtime shown at higher rate (e.g., 2x). Individual is paid overtime at more than 1.5x (e.g., 2x regular rate), and the individual receives a statement covering the entire 2025 tax year that shows the total overtime amount (premium at higher rate + regular wages for OT hours combined). Multiply the aggregate overtime amount by a fraction to isolate the FLSA premium; for 2x, use one-fourth. Example: $20,000 × 1/4 = $5,000.
E. Underestimation of Overtime. If the method for determining the amount of qualified overtime compensation described in paragraph B or D would result in underestimating the qualified overtime compensation (for example, an individual’s regular rate is increased due to a nondiscretionary bonus), the individual may adjust the method described in paragraph B or D above to take the difference into account.
F. No Annual Statement Available: If an individual is paid overtime at a rate described in paragraphs A-E above, but is not provided any statement covering the entire 2025 tax year separately accounting for the FLSA Overtime Premium, the aggregate dollar amount of FLSA overtime, or the aggregate dollar amount of overtime compensation paid at a higher rate, the individual may use a reasonable method that takes into account the regular rate under the FLSA paid to the individual (or a reasonable approximation thereof) and the individual’s hours of service in excess of 40 hours in a workweek (or a reasonable approximation thereof of the individual does not have records of actual hours of service) for purposes of determining the amount of qualified overtime compensation. The individual may request the information from the employer and use the information provided by such employer to calculate the deduction.
G. Public sector and healthcare workers with special FLSA rules: If an individual’s employer satisfies the requirements under 29 USC § 207 by operation of another subsection of the FLSA other than 29 USC § 207(a) (including but not limited to public sector employees in fire protection and law enforcement, employees of a political subdivision of a State or an interstate governmental agency who receives compensatory time off in certain circumstances in lieu of cash overtime compensation and employees of hospitals or certain residential care facilities), the individual must compute the amount of overtime compensation by operation of the different overtime rules used in the relevant provision of 29 USC § 207 that apply to the individual and may use any reasonable method contained in the Notice that takes those alternative overtime rules into account.
Transitional Relief and Penalties (2025)
- For tax year 2025, transition relief applies. Per IRS Notice 2025-62, no penalties will be assessed in connection with the implementation of the new information reporting requirements related to the deductions for qualified tips and qualified overtime compensation. This includes any penalties assessed under IRC section 6721 for failure to file correct information returns and the penalty under IRC section 6722 for failure to furnish correct payee statements.
- While not required to obtain the penalty relief described above, Notice 2025-62 encourages employers and payors to provide employees and payees with separate accountings of overtime compensation, cash tips, and occupation codes to facilitate employee determinations of whether they may claim the deductions.
- SSTB transitional relief (tips): For 2025 only, employees in customary tipped occupations may claim the tips deduction even if their employer is an SSTB, until January 1 of the first calendar year after final regulations are issued. See IRS Notice 2025-69 for more details.
Disclaimer: This summary provides general information only and does not constitute legal or tax advice. Individuals should consult with qualified tax professionals regarding their specific circumstances.