OBBBA Insight: How workers can claim new tax deductions for tips and overtime

On November 21, the IRS issued guidance to individual taxpayers eligible to claim the new income tax deductions for qualified tips and overtime pay created by the One Big Beautiful Bill Act (OBBBA).

Notice 2025-69 instructs workers on how to determine the amount of their deduction for tax year 2025 without receiving a separate accounting from their employer, such as on Form W-2 or Form 1099, which are unchanged for the 2025 tax year. The notice also provides transition relief to workers who receive tips in a specified service trade or business (SSTB).

Qualified Tips

Background

For tax years 2025-2028, employees and self-employed individuals may claim an above-the-line deduction for “qualified tips.” Qualified tips are voluntary cash or charged tips received from customers or through tip sharing.

The tips must be received in an occupation that customarily and regularly receives tips on or before December 31, 2024. The IRS previously issued proposed regulations identifying nearly 70 separate occupations of tipped workers eligible for the deduction (referred to as the “eligible jobs list”).

Tips received from a job that is an SSTB do not qualify for the deduction. An SSTB is a trade or business involving the performance of services in one of the following fields: health; law; accounting; actuarial science; performing arts; consulting; athletics; financial services; brokerage services; investing and investment management; trading; dealing in securities, partnership interests, or commodities; or any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners.

The deduction for qualified tips is capped at $25,000 and phases out for taxpayers with Modified Adjusted Gross Income (MAGI) over $150,000 ($300,000 for joint filers).

Guidance for Calculating Tips for Tax Year 2025

Because Form W-2 for 2025 has not been modified to account for the new tip reporting requirements by employers, Notice 2025-69 provides guidance to workers on calculating the amount of qualified tips eligible for deduction. An employee may calculate the amount of qualified tips by using one of the following options:

In addition to these three options, employees also may include any amount listed on line 4 of the 2025 Form 4137 filed with the employee’s 2025 income tax return. Example:

Assume Bill, a bartender, reports $20,000 in tips to his employer during 2025 on Forms 4070. Bill’s 2025 Form W-2 reports $200,000 of wages, tips, or other compensation in box 1 and $15,000 of Social Security tips in box 7. Bill also reports $4,000 of unreported tips on Form 4137, line 4, and includes this amount in income on his 2025 Form 1040. Bill may use either the $15,000 reported in box 7 of his Form W-2 or the $20,000 reported to his employer on Forms 4070 in determining the amount of qualified tips for tax year 2025. Regardless of the option he chooses, he may also include the $4,000 of unreported tips on Form 4137, line 4.

Non-employees, such as workers who receive Form 1099, may calculate qualified tips using earnings statements or other documentation, such as receipts, point-of-sale system reports, daily tip logs, or third-party settlement organization records.

SSTB Transition Relief

Employees are responsible for determining whether the tips they received were from an eligible job. However, Notice 2025-69 acknowledges that it may be difficult for employees to determine whether their tips were received in a job that qualifies as an SSTB. Therefore, the notice provides that a business will not be considered an SSTB if it is a job on the eligible jobs list in the IRS’s proposed regulations. This transition relief applies until January 1 of the first calendar year following the issuance of final regulations regarding the determination of whether a business is an SSTB for purposes of the qualified tips deduction.

Overtime Pay

Background

For tax years 2025-2028, individuals may claim an above-the-line deduction for “qualified overtime compensation.”

Qualified overtime compensation:

— is the pay required by the Fair Labor Standards Act (FLSA) that exceeds an individual’s regular rate of pay. Unless exempt, employees covered by the Act must receive overtime pay for hours worked over 40 in a workweek at a rate not less than time and one-half their regular rate of pay;

— does not include qualified tips.

The deduction is capped at $12,500 ($25,000 for joint filers) and phases out for taxpayers with MAGI over $150,000 ($300,000 for joint filers).

Guidance for Tax Year 2025

Only the FLSA-required overtime premium (“FLSA Overtime Premium”) – that is, the “half” portion of “time-and-a-half” pay – is deductible. This complicates the calculation of deductible overtime compensation when an employer pays a higher rate, such as double time, or pays overtime wages even when an employee does not work more than 40 hours in a week. Notice 2025-69 explains how to calculate the amount of qualified overtime compensation through a series of examples, some of which are summarized below.

Notice 2025-69 also provides guidance on more complex situations, including employees subject to alternative overtime rules under the FLSA, such as law enforcement personnel and hospital employees.

If you have questions on the new deductions for qualified tips and overtime pay, and how best to report these, please contact your Dean Dorton or other professional advisor.