Dear Client,
The IRS has issued guidance for taxpayers eligible to claim the deduction for tips and for overtime compensation for the 2025 tax year. The guidance clarifies for taxpayers how to determine the amount of their deduction without receiving a separate accounting from their employer for cash tips or qualified overtime on information returns such as Form W-2 or Form 1099s, as those forms remain unchanged for the current tax year. It also provides transition relief to workers who receive tips in the course of a specified service trade or business.
Qualified Tips Deduction
Under the OBBB Act, eligible individuals can claim an income tax deduction for qualified tips received in tax years 2025 through 2028. A “qualified tip” is any cash tip received in an occupation that customarily and regularly receives tips on or before December 31, 2024, and is subject to certain limitations.
The deduction is limited to $25,000 per tax year and starts to phase out when modified adjusted gross income (AGI) is above $150,000 ($300,000 for joint filers). The allowable qualified tip deduction amount phases out completely when the taxpayer’s modified AGI reaches $400,000 ($550,000 for joint filers). Married taxpayers must file jointly to claim the deduction. Amounts that do not meet certain requirements are excluded from the qualified tip treatment.
An employer reports qualified tips on the employee’s Form W-2, or the employee must report the tips on Form 4137. A service recipient reports qualified tips on the nonemployee payee ‘s Form 1099-NEC or Form 1099-K.
Qualified Overtime Compensation Deduction
Under the OBBB Act, individuals can claim an income tax deduction for qualified overtime compensation received in tax years 2025 through 2028. The deduction is limited to $12,500 per tax year ($25,000 per tax year for joint filers) and starts to phase out when modified AGI is over $150,000 ($300,000 for joint filers). The allowable qualified overtime compensation deduction amount phases out completely when the taxpayer’s modified AGI reaches $275,000 ($550,000 for joint filers).
“Qualified overtime compensation” is overtime paid to an individual required under the Fair Labor Standards Act of 1938 (FLSA) that is in excess of the regular rate under the FLSA at which the individual is employed. Under the FLSA, employers generally must pay covered, nonexempt employees at least one-and-a half times their regular rate of pay for hours worked over 40 hours a week at a given job. The “regular rate” of pay generally includes all remuneration for employment paid to the employee, but certain types of payments are excluded. An employer reports qualified overtime compensation on Form W-2, Form 1099, or other specified statement furnished to the individual.
Calculating Qualified Tips For the 2025 Tax Year
Employees can use the following to calculate qualified tips:
- Social Security tips on Box 7 of Form W-2,
- Total tips reported on Forms 4070,
- Include any unreported tips listed on Form 4137 (line 4), and/or
- Employer reported tips on Box 14 of W-2.
Non-Employees can use the following to calculate qualified tips:
- Totals from Forms 1099-MISC, 1099-NEC, or 1099-K, and/or
- Supplement with records: tip logs, point of sale reports, receipts, or payor statements.
Calculating Qualified Overtime Compensation For the 2025 Tax Year
If the employer provides separate accounting, use the stated FLSA overtime premium amount from Forms W-2 or 1099s. If no separate accounting is used, use one of the reasonable methods provided to estimate FLSA overtime compensation.
Contact Us
Please call our office if you would like to discuss how you might benefit from the qualified tips and overtime compensation deductions, as well as how to calculate the amounts for the 2025 tax year. We are here to assist.