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Under the One Big Beautiful Bill Act (OBBBA), for tax years 2025-2028, eligible individuals can claim deductions for qualified tips and overtime compensation. The new law requires employers and other service recipients to include qualifying amounts on Forms W-2 and 1099, but transition relief delays these reporting obligations for one year, such that employers are not required to change their Form W-2 reporting for tips and overtime paid in 2025. However, employers should be prepared for questions from their employees who are interested in claiming these tax deductions and also take steps to prepare for changes in tax reporting for 2026.
What are the new OBBBA tax deductions for qualified tips and overtime?
Eligible employees and self-employed individuals working in occupations that customarily and regularly received tips before 2025 may deduct up to $25,000 of qualified tips, subject to a phaseout for individuals with modified adjusted gross income over specified thresholds. The IRS has published a list of occupations customarily and regularly involving tips, including food and beverage, entertainment, hospitality, transportation, and personal services. Qualified tips must be paid in cash and must be paid voluntarily (tips received under a tip-sharing arrangement are eligible, but mandatory service charges are ineligible). Individuals and employees working for an employer engaged in a "specified service trade or business," including health, law, performing arts, and financial services, are not eligible to claim the deduction.
Non-exempt (usually hourly) employees and self-employed individuals who are covered by the Fair Labor Standards Act (FLSA) may claim a deduction for qualified overtime compensation. The deduction only applies to non-exempt employees' overtime pay required by FLSA section 7 that exceeds their regular rate of pay. As a result, overtime paid after eight hours, as required by some state laws, is not deductible, and exempt employees (usually salaried) who may earn overtime under a "straight time pay after 40 hours of work" policy also cannot take this deduction. Other overtime, including compensation paid under a collective bargaining agreement or under other state law, is also not deductible. The maximum annual deduction is $12,500 ($25,000 for joint filers) and, like the deduction for tips, is phased out for individuals with modified adjusted gross income exceeding specified thresholds.
What is an employer required to report for qualified tips or overtime?
Employers and other service recipients are required to separately report the amounts of qualified tips and qualified overtime compensation paid and to identify the recipient's occupation on Forms W-2 and 1099. The IRS is not releasing updated forms for 2025 reporting, but updated tax forms are expected to be released for 2026.
What relief is available to employers and individuals for 2025?
In November, the IRS announced transition relief for individuals claiming these deductions and for employers and other service recipients required to report qualifying amounts. In recognition of the fact that employers may not currently have the information required to be reported, the IRS will not impose information reporting penalties on employers or other payors for failing to include this information on information returns filed and furnished with respect to 2025 as long as the forms filed and furnished are otherwise complete and correct. However, employers and other payors are "encouraged" to provide individuals with occupation codes and separate accountings of cash tips and qualified overtime compensation. This information can be made available through an online portal, additional written statements furnished to the individuals, Box 14 Form W-2 (for qualified overtime only), or any other secure method.
For 2025, individuals in occupations customarily and regularly receiving tips before 2025 will be allowed to claim the deduction for qualified tips as long as the tips are included in the total amount of wages or other compensation reported on Form W-2 or 1099 (even if these amounts are not separately accounted for) and the amount deducted is calculated under one of several designated methods. The rules on specified service trades or businesses are suspended until final Treasury Regulations are published, which means that cash tips will be treated as qualified tips for 2025 so long as the individual is in one of the listed occupations that customarily and regularly receives tips.
For the qualified overtime compensation deduction, for 2025, individuals are required to make a reasonable effort to determine whether they are FLSA-eligible, which may include asking their employer or other service recipient about their status under the FLSA. FLSA-eligible individuals may claim the deduction if qualified overtime compensation is included in the total amount of wages or other compensation reported on Form W-2 or 1099 (even if these amounts are not separately accounted for) and they base the determination of the amount of qualified overtime using other documentation (such as earnings or pay statements) using one of several designated methods. The IRS guidance acknowledges that these documents may include overtime compensation that is required due to union or state rules, rather than the FLSA, and allows individuals to approximate their FLSA overtime premiums by using pay statements or other documents.
What should employers do now?
- Employers should consider whether to voluntarily provide employees with information about qualified tips and overtime compensation paid in 2025 and for employees receiving tips, occupation codes.
- Employers should be prepared to respond to questions from employees, including whether employees are FLSA-eligible.
- Employers should work with their payroll providers to track and separately report qualified tip and overtime compensation in 2026. These actions include updating payroll recordkeeping systems to identify employees who are eligible to receive qualified tips and their occupation codes and to track qualified overtime (i.e., FLSA section 7 required overtime that exceeds an employee's regular rate of pay) separately from other overtime compensation.
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