IRS Will Not Impose Penalties Based on Reporting of “No Tax on Tips” and “No Tax on Overtime” for 2025

In a welcome development for employers that were struggling to determine how to comply with the reporting requirements of the “One Big Beautiful Bill Act” relating to “no tax on tips” and “no tax on overtime,” the IRS announced this week that employers will not face penalties for failing to comply with the Act’s reporting requirements for tax year 2025.

The Act provides above-the-line tax deductions for certain “qualified tips” and “qualified overtime compensation.” To facilitate these deductions, the Act requires employers to include the following information on Form W-2: (a) the total amount of cash tips reported by the employee; (b) the employee’s tipped occupation; and (c) the amount of qualified overtime compensation paid to the employee. The Act left open several questions, including: (a) how to calculate the amount of qualified overtime compensation; and (b) where to report this information on Form W-2.

As to the first question, the Act authorizes the reporting party to “approximate” the amounts designated as qualified overtime compensation pursuant to a “reasonable method” to be specified by the Treasury secretary. While the IRS committed in August to providing guidance “in the coming months” on the “reasonable method” that employers should use to “approximate” this amount, no such guidance has been provided.

As to the second question, the IRS announced that Form W-2 “will remain unchanged” for tax year 2025, leaving employers to wonder where they should report the information. Making matters more confusing, the IRS published a draft Schedule 1-A in September informing taxpayers that their qualified overtime compensation would be included in Form W-2, box 1. Of course, box 1 is where employers report the total taxable wages, tips, and other compensation paid to the employee, not just the amount of qualified overtime compensation.

Employer concerns about the lack of guidance were mitigated somewhat by the IRS’s commitment over the summer to providing “transition relief” for tax year 2025. This week, the IRS confirmed that it would provide complete penalty relief to employers for tax year 2025 regarding the reporting requirements relating to cash tips and qualified overtime compensation under the Act. In announcing the transition penalty relief, the IRS acknowledged that because the Act did not take effect until July 2025, employers may not yet have the information required to be reported under the Act dating back to January 1 or the systems in place to be able to include the information on Form W-2.

As a result, employers will not face penalties for failing to provide an accounting of any amounts reasonably designated as cash tips or the occupation of the person receiving such tips. In addition, employers will not face penalties for failing to provide a report of the total amount of qualified overtime compensation paid to an employee. The relief is limited to tax year 2025 and applies only to the extent that the reporting party otherwise files and provides a complete and correct return or statement.

As part of its announcement of penalty relief, the IRS “encouraged” employers to: (a) provide employees in tipped occupations with their occupation codes as well as an accounting of their cash tips; and (b) provide employees with an accounting of their qualified overtime compensation. The IRS encouraged employers to make the information available to their employees through an online portal, written statements provided to the employees, other secure methods, or (in the case of qualified overtime compensation) in box 14 of Form W-2.

While the IRS’s announcement of transition penalty relief for tax year 2025 is welcome news, employers should still make every effort to provide employees with an accurate report showing (a) the total amount of cash tips reported; (b) the qualifying tipped occupation; and (c) the amount of qualified overtime compensation paid. To be sure, employees are expecting to receive this information by January 31, 2026, so that they can claim their deductions. Moreover, employers will need to be prepared to accurately calculate the amount of qualified overtime compensation paid in tax year 2026 (e.g., to ascertain what portion of wages designated as “overtime” on an earning statement constitutes “qualified overtime” under the Act), when the penalty relief will no longer apply. 

Employers navigating the Act’s reporting requirements are encouraged to consult with experienced employment counsel to make certain that they are prepared to: (a) provide information to their employees by January 31, 2026, so that they can claim their deductions for tax year 2025; and (b) accurately calculate the amount of qualified tips and qualified overtime compensation paid beginning January 1, 2026.