IRS clarifies how employees can claim 2025 tip and overtime deductions

The IRS issued guidance for workers eligible to claim the temporary deductions for tip and overtime compensation for tax year 2025 and is updating some income tax forms and instructions to help taxpayers claim the deductions.

Notice 2025-69, published Friday, clarifies how workers can determine the deduction amount without receiving a separate accounting from their employer for cash tips or qualified overtime on information returns such as Form W-2, Wage and Tax Statement, or a Form 1099.

H.R. 1 provisions

The provisions on tip and overtime compensation were enacted as part of H.R. 1, P.L. 119-21, commonly known as the One Big Beautiful Bill Act. For tipped workers, the maximum annual deduction is $25,000, which phases out for taxpayers with modified adjusted gross income (AGI) over $150,000 ($300,000 for joint filers).

For those who receive qualified overtime, the maximum annual deduction is $12,500 ($25,000 for joint filers). The deduction phases out for taxpayers with modified AGI over $150,000 ($300,000 for joint filers).

Guidance necessary for tax year 2025

The IRS published the guidance because it previously said it will not update the 2025 versions of Form W-2; Form 1099-NEC, Nonemployee Compensation; Form 1099-MISC, Miscellaneous Information; or Form 1099-K, Payment Card and Third Party Network Transactions, to include the new tip and overtime deductions, which are effective for tax years 2025 through 2028.

However, the IRS said in a news release Friday that it is updating income tax forms and instructions for taxpayers for tax year 2025. Such tax forms include Form 1040, Schedule 1-A, Additional Deductions, which the IRS released in draft form earlier this month and includes entries for tips.

The changes are part of significant ones introduced for the 2025 tax year by the legislation signed into law over the summer.

In addition to tip and overtime changes and numerous other changes, new deductions have been established for seniors and for car loan interest. Also, the law calls for increased standard deduction amounts and higher state and local tax limits.

Catch-up contribution limits for individuals aged 60–63 have been raised, and new reporting requirements apply to digital assets via Form 1099-DA, Digital Asset Proceeds From Broker Transactions. The child tax and adoption credits have been updated, and new Trump accounts for children born after 2024 and before 2029 have been introduced.

Examples of guidance for tipped workers

Notice 2025-69 provides examples to illustrate situations tipped employees might encounter, including that of a bartender with additional reported tips on Form 4137, Social Security and Medicare Tax on Unreported Tip Income.

In one example, a bartender reports $20,000 in tips to his employer during the 2025 tax year on Forms 4070, Employee’s Report of Tips to Employer, and $4,000 of unreported tips on line 4 of Form 4137. His Form W-2 reports $200,000 in box 1 and $15,000 in box 7. 

According to the example, the bartender may use either the $15,000 in box 7 of Form W-2 or the $20,000 of tips reported to his employer on Forms 4070 in determining the amount of qualified tips for tax year 2025. In either case, the bartender may also include the $4,000 of unreported tips from line 4 of Form 4137 in determining the amount of qualified tips.

Overtime deduction

Individuals who receive qualified overtime compensation during the temporary period may deduct the pay that exceeds their regular rate of pay (generally, the “half” portion of “time-and-a-half” compensation) that is required by the Fair Labor Standards Act (FLSA) and reported on a Form W-2, Form 1099, or other specified statement furnished to the individual.

Generally, the FLSA requires that most employees in the United States be paid at least the federal minimum wage for all hours worked and overtime pay at not less than time and one-half their regular rate of pay for all hours worked over 40 in a workweek. However, the law includes exemptions.

The IRS said that Notice 2025-69 does not affect any rights or responsibilities regarding tip or overtime compensation under the FLSA.

Overtime examples

Notice 2025-69 provides a series of examples illustrating situations that workers who receive qualified overtime might encounter. The IRS included abridged versions of some of those examples in IR-2025-114, also released on Friday.

In one of the abridged overtime examples in the news release, an employee who receives a payroll statement from an employer that shows $5,000 as the overtime premium that the employee was paid during 2025 may include $5,000 (the FLSA overtime premium) to determine the amount of qualified overtime compensation received in tax year 2025.

In a second abridged example, the same facts as the first example are assumed, except that the payroll statement shows a total overtime amount of $15,000, which is the total amount the employee was paid for working overtime (the FLSA overtime premium combined with the portion of his regular wages). The employee may include the $5,000 FLSA overtime premium, computed by dividing $15,000 by three, in determining the amount of qualified overtime compensation for 2025.

In a third abridged example, an employer pays overtime at a rate of two times an employee’s regular rate of pay. One employee was paid $20,000 in overtime and her last pay stub shows overtime of $20,000 was paid in 2025. For purposes of determining the amount of qualified overtime compensation received in tax year 2025, she may include $5,000 ($20,000 divided by 4).

— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.