IRS Provides Guidance for Taxpayers to Claim Deductions for Qualified Tips and Qualified Overtime Compensation

Employees have been wondering how they will determine the amount of their qualified tips and qualified overtime eligible for deduction under the One Big Beautiful Bill Act. After all, the IRS is not changing Form W-2 for tax year 2025, and employers will not face penalties for failing to comply with the Act’s reporting requirements for tax year 2025. Against this backdrop, how is an employee supposed to know the amount of their deduction? On November 21, 2025, the Internal Revenue Service (IRS) published guidance intended to answer that question.

No Tax on Tips

The IRS guidance provides that 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 that amount. Otherwise, the employee may determine their qualified tips for tax year 2025 by reference to: 

1. The social security tips reported in box 7 of the Form W-2; and
2. The tips reported by the employee to the employer on Form 4070 (Employee’s Report of Tips to Employer) or similar substitute forms.

In addition, the employee may include any amount listed on line 4 of their 2025 Form 4137 filed with their 2025 income tax return (and included as income on that return).

The IRS guidance reminds taxpayers that the “no tax on tips” deduction applies only to tips received by employees in an occupation that customarily and regularly received tips on or before December 31, 2024, as provided by the treasury secretary. For tax year 2025, employers may choose to provide information on an employee’s occupation using box 14 of Form W-2, in which case employees may rely on that information. Otherwise, the employee will be responsible for determining whether their occupation qualifies for the deduction. The IRS guidance refers taxpayers to its proposed regulation identifying 68 such occupations.

No Tax on Overtime

The IRS guidance reminds taxpayers that the “no tax on overtime” deduction is limited to overtime compensation that is required by the Fair Labor Standards Act (FLSA), and only to the extent that it exceeds the individual’s regular rate (i.e., the “half” of “time and a half”). The IRS acknowledges that some employers pay overtime that is not required by the FLSA, either due to state law (e.g., daily overtime required in California and a few other states) or a collective bargaining agreement, or simply due to the employer’s own initiative in being more generous than required (e.g., counting PTO hours as “hours worked” for purposes of overtime). The IRS guidance makes clear that only overtime required by the FLSA (and only the “half time” overtime premium) qualifies for the deduction; payments in excess of the FLSA-required premium do not qualify.

The IRS encourages employers to provide employees with a statement of their qualified overtime compensation for tax year 2025. If an employer provides that information (e.g., in box 14 of the Form W-2 or in a separate statement), the employee may rely on that information. If the employer does not provide that information, the employee may determine the amount of qualified overtime compensation using other documentation such as time records and earning statements, using a “reasonable method” to determine the correct amount.

The IRS explains that if the individual is paid overtime compensation based exclusively on FLSA Section 7 requirements – i.e., at a rate of one and one-half times their regular rate for hours worked in excess of 40 hours in a workweek – and receives a statement covering the entire 2025 tax year (e.g., the final wage statement of 2025 shows a “year to date” amount):

1. If the statement separately reports the overtime premium as the “half” portion of “time and a half” on its own line, the individual may use that amount.
2. If the statement reports a “time and a half” number, the individual may use one-third of that amount, since one-third of the total amount presumably reflects the half-time overtime premium.
3. If the statement reports a number based on a rate above a “time and a half” number, the individual may use an appropriate fraction to isolate the FLSA-required premium amount. For example, if an employer voluntarily pays “double time” for overtime worked on weekends, then one-quarter of that amount would presumably reflect the overtime premium required by the FLSA.

If the individual is paid overtime compensation that exceeds FLSA requirements, the IRS instructs the employee to use a “reasonable method” that takes into account: (a) their hours worked in excess of 40 per workweek; and (b) their FLSA regular rate for the week. The IRS suggests “requesting information from the individual’s employer” for this purpose. In general, it is expected that in any given workweek, the amount of qualified overtime will be equal to one-half the employee’s regular rate for the week multiplied by the number of hours worked in excess of 40 that week. In light of this guidance, employers should be prepared to respond to employee inquiries about their FLSA regular rate and hours worked on a weekly basis.

Final Thoughts

First, employers should remember that both tips and overtime are still wages subject to income tax withholding, Social Security and Medicare taxes, and state and local taxes. Employees are still responsible for claiming the deduction on their own income tax returns and determining if they qualify to do so (for example, by determining whether they meet the income thresholds to claim the deduction). Thus, from a tax perspective, these rules do not change employers’ existing tax withholding, reporting, and remitting obligations.

Second, employers now have the additional obligation to report the “qualified” amounts to employees. While the IRS is providing penalty relief for tax year 2025, employers should be prepared to explain to their employees whether they will be providing information regarding qualified tips and qualified overtime compensation (and if so, when and how it will be provided). Ultimately, though, individual taxpayers will be responsible for the accuracy of their own tax returns for tax year 2025. Employers may want to conclude any employee-facing communication about the “no tax on tips” and “no tax on overtime” deductions with a standard disclaimer that the employer is not providing tax advice and that employees may wish to consult a tax professional.

While the IRS does not require strict adherence to the Act’s reporting requirements for tax year 2025, employers should still make every effort to provide employees with a report showing (a) the total amount of cash tips reported; (b) the qualifying tipped occupation; and (c) the amount of qualified overtime compensation paid. After all, employees expect to receive this information from their employers so that they can take advantage of these deductions. Moreover, employers will need to be prepared to accurately calculate the amount of qualified overtime compensation paid in tax year 2026, when the penalty relief will no longer apply.