Alert

IRS Issues Employee Guidance on “No Tax on Tips”  & “No Tax on Overtime” Deductions

December 1, 2025

The Internal Revenue Service (IRS) recently issued guidance to individuals on how to claim the deduction for qualified tips and qualified overtime compensation. Among other helpful measures, the guidance relieves individuals claiming the deduction for qualified tips from determining whether the tips were received in a specified service trade or business.

Background

The One Big Beautiful Bill (OBBB) created a deduction for qualified tips received by employees and self-employed individuals, subject to limitations, and a deduction for qualified overtime pay, also subject to limitations[1].

The provisions of OBBB that enacted the deduction for qualified tips and qualified overtime pay require employers (and other payors) to provide employees (or non-employees) with the information necessary for the employee or non-employee to claim these deductions. Because employers (and other payors) may not have time to provide the required information to employees (or non-employees) for the 2025 taxable year, the IRS has excused employers (and other payors) from providing the required information.

To provide guidance to employees and self-employed individuals on how to claim the deduction for qualified tips and qualified overtime pay in the absence of information provided by the employer, the IRS issued Notice 2025-69, “Guidance for Individual Taxpayers who received Qualified Tips or Qualified Overtime Compensation in 2025.”

Deduction for Tip Income

Determining the amount of qualified tips received by employees under Notice 2025-69

To enable employees to claim a deduction for qualified tips, employers are required to separately account for cash tips on IRS Form W-2, and report the employee’s occupation. As explained below, only tips received for certain occupations are deductible.

Employees may also claim the deduction for tips they report on IRS Form 4137, Social Security and Medicare Tax on Unreported Tip Income. Form 4137 is used by employees to report tips that the employee did not report to his or her employer. For example, Jane is a server in a restaurant and received $5,000 in tips that were paid on a credit card and reported to the employer. She also received $1,000 in cash tips that she did not report to the employer. If Jane reports the $1,000 in cash tips on Form 4137, she can claim a deduction for $6,000 in tip income ($5,000 credit card tips plus $1,000 cash tips reported on Form 4137), assuming she meets the other requirements for claiming a deduction for tip income.

To recap from the Alerts and Podcasts referenced above, only qualified tips are eligible for the deduction, and there are several requirements for tips to be qualified tips, which include:

• Tips must be received in an occupation that customarily and regularly received tips before 2025. IRS issued proposed regulations that list 68 categories of occupations that meet this requirement;
• Tips must be voluntary on the part of the person paying the tip. An added “service” charge is not voluntary, and, therefore, not a qualified tip;
• Tips received for a service that is a felony or misdemeanor are not qualified tips; and
• Tips received in a specified service trade or business are not qualified tips. These include tips received in the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any other trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.

The IRS has not modified the 2025 Form W-2 to account for the new tip reporting requirements. As a result, employers are not required to separately account for cash tips on the written statements furnished to individuals for 2025.

What must an employee do to claim the deduction for qualified tips for 2025?

1. Report all the tips reported on Form W-2; and
2. Calculate the amount of qualified tips (subject to the other limitations and requirements for qualified tips) using one of these three options:
   a) Use the total amount of social security tips reported in box 7 of the Form W-2;
   b) Use the total amount of tips reported by the employee to the employer on all IRS Forms 4070, Employee’s Report of Tips to Employer (or any similar substitute form used to monthly report tips to the employer); or
   c) If an employer voluntarily chooses to report the amount of an employee’s cash tips in box 14 of Form W-2 (or on a separate statement), the employee may use this amount in determining the amount of qualified tips for tax year 2025.
3. In addition to these three options, employees may also include any amount listed on line 4 of the 2025 Form 4137 filed with the employee’s 2025 income tax return (and included as income on that return).

Employees are responsible for determining whether the tips they received were received in an occupation that customarily and regularly received tips before 2025, even if the employer does not include this information on the 2025 Form W-2.

As noted above, tips received in a specified service trade or business are not qualified tips, and, therefore, not eligible for the deduction. The IRS recognizes that employers and employees will need guidance to determine whether the employee receives tips in a specified service trade or business, and plans to issue such guidance. Therefore, it is providing transitional guidance until January 1 of the first calendar year following the issuance of final regulations regarding the determination of whether a trade or business qualifies as a specified service trade or business.

Under the transitional guidance, an employee will be treated as having received tips in the course of a trade or business that is NOT a specified service trade or business if the employee is in an occupation that customarily and regularly received tips before 2025. Thus, if the employee’s occupation is listed in the 68 occupations the IRS listed in the proposed regulations, the employee will not be treated as receiving tips in a specified service trade or business.

What must a non-employee do to claim the deduction for qualified tips for 2025?

Non-employees do not receive a Form W-2, but should receive either a Form 1099-MISC, 1099-NEC, or 1099-K. The provision of the OBBB that provides for a deduction for qualified tips received by a non-employee requires the person making the payment (the payor) to include on the applicable Form 1099 the portion of (or separate accounting of) payments that have been reasonably designated as cash tips and the occupation of the individual receiving the tips. Only cash tips separately accounted for on the applicable Form 1099 are eligible for the deduction. (For this purpose, “cash tips” include tips received in cash or charged, as well as tips received under any tip-sharing arrangement.)

Because the IRS has excused employers and other payors from designating cash tips and the occupation of the individual receiving the tips, the IRS is providing transitional guidance. Under the transitional guidance, the non-employee may claim a deduction for qualified tips if the cash tips are included in the total amounts reported as income on the Form 1099-MISC, non-employee compensation on Form 1099-NEC, or payment card/ third-party network transactions on the Form 1099-K furnished to the non-employee.

The transitional guidance for employees regarding whether a trade or business is a specified service trade or business will also apply to non-employees.

Deduction for Qualified Overtime Compensation

Only Fair Labor Standards Act (FSLA) overtime can be deducted.

To claim the deduction for overtime pay, an employee must be eligible for overtime under federal law. This means that the employee must be an FLSA-eligible non-exempt employee. If the individual is FLSA-ineligible (i.e., exempt from FLSA overtime requirements), then the overtime compensation paid under state or other rules generally do not apply. Furthermore, if an employee receives overtime or premium pay solely due to state law, collective bargaining agreements, or employer policies, they are not eligible for the overtime compensation deduction because the deduction applies to overtime mandated by federal law.[2]

Determining the amount of qualified overtime compensation received by employees under Notice 2025-69

Under the OBBB, employees are entitled to a deduction for qualified overtime compensation received during the taxable year. According to Notice 2025-69, “qualified overtime compensation” is defined as overtime compensation paid to an individual required under the Fair Labor Standards Act of 1938 (29 USC § 207) that is in excess of the regular rate at which the individual is employed. This generally means hours worked over 40 hours in a week, but the FLSA contains special overtime rules for certain employers and employees. For example, firefighters and law enforcement personnel employed by public agencies may have overtime calculated over a longer work period rather than a standard 40-hour workweek. Hospitals or residential care facilities may choose to base overtime hours off hours worked over eight hours in a day or over 80 hours in a two-week period, whichever is more.

It is important to note, however, that only the portion of overtime compensation that corresponds to the premium above the regular rate is eligible. For example, the “premium” is the “½ time” portion when paid 1 ½ for overtime hours.

Methods for determining the amount of qualified overtime compensation

Under the OBBBA, employers are required to separately account for qualified overtime compensation on Forms W-2. As noted above, however, the IRS announced that the 2025 Form W-2 will not include a separate section for reporting qualified overtime compensation. As a result, employers are not required to report qualified overtime compensation, and will not be penalized for not providing separate accounting. Therefore, employees must determine the amount of qualified overtime by following the IRS transitional guidance for the 2025 tax year.

If an employer chooses to report the amount of overtime compensation received by an employee using box 14 of Form W-2 or on a separate statement, then employees may treat the separate accounting requirement as satisfied, and claim a deduction for the amount reported. If the employer chooses not to report such amount, then an employee may report the qualified overtime compensation using more flexible methods.

To be eligible to use the flexible methods, (1) the qualified overtime compensation must be reported on the Form W-2 the employee receives (without regard to the separate accounting for the qualified overtime compensation), and (2) the determination on the amount of qualified overtime compensation must be based on documentation such as earnings, pay statements, or similar statements that support the determination.

Provided these requirements are met, Notice 2025-69 outlines the following acceptable methods for determining the amount of qualified overtime compensation that will be reported on 2025 tax forms:

1. If overtime is paid at the standard 1.5x rate and the premium portion (extra 0.5x) is listed separately on a year-end statement, the individual may simply use that amount.
   Example: If at the end of 2025, a payroll system shows that $5,000 was paid to the employee as the “overtime premium” for the 2025 year, then the employee may report the $5,000 for purposes of determining the amount of overtime compensation received.
2. If the overtime is paid at 1.5x, but the premium portion is not separately listed, and only a combined overtime amount is shown, the individual may treat 1/3 of that total as qualified overtime compensation.
   Example: If an employee’s paystub shows a total overtime amount of $15,000 (regular wages plus FLSA Overtime Premium), the individual may include $5,000 (1/3 of $15,000) for purposes of determining the amount of overtime compensation received.
3. If overtime is paid at a rate higher than 1.5x (e.g., 2x) and the portion in excess of the employee’s regular rate is listed separately, the employee may multiply that separate amount by an appropriate fraction to approximate the FLSA overtime premium.
   Example: If paid overtime at 2x, multiply by ½. So if the paystub reports the separate amount as $10,000, then multiply it by ½ to equal $5,000.
4. If the overtime rate is higher than 1.5x and the extra portion is NOT listed separately and instead listed as a combined amount, then the individual may multiply the combined amount by a smaller fraction.
   Example: If paid overtime at 2x, multiply the combined amount by ¼.
5. If the method for determining the amount of overtime compensation in (2) or (4) would result in an underestimation, the individual may adjust the method to account for the difference.
6. If no year-end statement lists overtime amounts at all, the employee may use any reasonable methods based on their regular rate and hours worked over 40 hours in a week, including information obtained by requesting records from the employer.
7. If the employee is subject to special FLSA overtime rules, the individual must calculate overtime using those specific rules and then apply any reasonable method above that fits.

The IRS guidance acknowledges that documents such as earnings statements and pay stubs take a variety of forms. Accordingly, employees may use amounts reported as overtime compensation on earnings statements, pay stubs, and other documentation provided by employers to calculate the FLSA Overtime Premium for 2025.

Until the IRS updates its Forms W-2, 1099-MISC, 1099-NEC, and 1099-K to require the information needed for employees and non-employees to determine their qualified tips and qualified overtime compensation, employees and non-employees will need to determine these amounts to claim the deductions. To ease the burden of determining the amounts, the IRS has provided helpful guidance in Notice 2025-69.

McGlinchey has a team of employment and tax lawyers ready to assist with questions regarding the deduction for tips and overtime compensation and other employment and tax matters.

[1] For background information, see:

Tax Deductions on Tips and Overtime Under Trump Tax Plan

Podcast: “Big, Beautiful” Changes, Pt. 1: No Tax on Tips

Podcast: “Big, Beautiful” Changes, Pt. 2: No Tax on Overtime

IRS Provides Penalty Relief for Information Reporting for No Tax on Tips and Overtime Pay

[2] Under the Internal Revenue Code, certain workers that would be classified as employees under the common law criteria are not treated as employees for tax purposes. These are statutory non-employees (generally, direct sellers, licensed real estate agents, and companion sitters.) The OBBB contains a provision that would permit payments to certain persons not treated as employees under the tax laws to be eligible for the deduction for overtime compensation.