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The Internal Revenue Service (IRS) has announced that it will not seek penalties against employers for failure to meet reporting requirements concerning overtime compensation and cash tips for the 2025 tax year. The One Big Beautiful Bill Act (OBBBA) that President Donald Trump signed into law on July 4, 2025, instituted new IRS reporting requirements and penalties for employers who failed to meet those requirements.
Although the IRS has specifically waived penalties for tax year 2025, employers still should begin preparing for the OBBBA reporting requirements in upcoming tax years. The provision of this information will allow employees to claim new tax deductions, i.e., the "qualified overtime" deduction under the Fair Labor Standards Act (FLSA) and the "qualified tips" deduction, which Congress established in the OBBBA.
Under the "qualified overtime" deduction, eligible employees can deduct up to $12,000 (or $25,000 for joint filers) from their federal taxable income based on the premium portion of their overtime earnings. The new deduction defines the premium portion of overtime pay as the extra half-time wage received for working more than 40 hours in a workweek under the FLSA. An employee's ability to claim the qualified overtime deduction begins to phase out once the employee's modified adjusted gross income (MAGI) is more than $150,000 annually (or $300,000 for joint filers).
Additionally, under the "qualified tips" deduction, individuals can deduct cash tips received while working in an occupation that customarily and regularly receives tips during the 2025 tax year. Qualified tips include tips that are determined and paid voluntarily without any consequence for nonpayment; therefore, mandatory gratuities and service charges are not included in the definition of qualified tips. Individuals may deduct a maximum of $25,000 in qualified tips (or $50,000 for joint filers). As with the qualified overtime deduction, eligibility for the qualified tip deduction begins to phase out when an individual's MAGI is more than $150,000 (or $300,000 for joint filers).
Since some states have daily overtime requirements that exceed those provided by federal law, employers in those states will have to set up systems that allow them to separate overtime paid under the FLSA from overtime paid for any other reasons. Affected states include Alaska, California, Colorado, Nevada, and Oregon in some industries.
Due to the need to establish these new systems and procedures to separate the relevant amounts of overtime paid, the IRS has said that they will not assess penalties against employers and other payors who fail to provide a separate accounting of the total amount of qualified overtime compensation, amounts reasonably designated as cash tips, or the occupation of the person receiving the tips. However, the IRS is limiting the penalty relief to income tax returns and statements filed and provided to the IRS for tax year 2025. The IRS also stated that the relief is available only for those who file and provide a complete and correct return or statement.
The IRS further announced that it will not update Forms W-2 and 1099 for tax year 2025 to reflect the OBBBA changes. Instead, the agency will treat 2025 as a transition period for IRS administration and enforcement of the new reporting requirements.
Nonetheless, the IRS is encouraging employers and payors to provide occupation codes and separate accountings of cash tips to allow employees and payees to claim the qualified tips deduction for tax year 2025. Similarly, the IRS is hopeful that employers will offer employees separate accountings of overtime pay to allow them to claim the qualified overtime compensation deduction for tax year 2025. For instance, employers can provide this information to employees through an online portal, separate written statements, or other secure means. Employers also can include qualified overtime compensation in Box 14 of the employee's Form W-2.
Employers also can take other steps to prevent penalties and make it easier for employees to claim the new deductions. For instance, employers should evaluate the scope and capabilities of their current payroll and human resource information system (HRIS) and determine whether the vendor will be providing any updates to comply with the new reporting requirements. Employers also can ease the process of claiming the new deductions for employees by providing the new information for tax year 2025, if feasible, and publicizing the availability of the new deductions. Alternatively, if employers cannot provide the needed information, they can give instructions about how employees can access and track needed data.
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