OBBBA Update: Qualified Tips and Overtime Compensation for Tax Year 2025

The One Big Beautiful Bill Act (OBBBA), enacted as Public Law 119-21, introduced two new above-the-line deductions for tax years 2025 through 2028: qualified tips and qualified overtime compensation. These provisions aim to provide relief for workers in tipped occupations and those earning federally required overtime pay, while creating new compliance considerations for tax professionals. This blog explains eligibility, substantiation, phase-outs, and practical examples to help practitioners advise clients effectively.

Statutory & Regulatory Framework

Sections 70201(a) and 70202(a) of OBBBA added new IRC §224 (qualified tips) and IRC §225 (qualified overtime compensation). Guidance for the 2025 tax year was issued in Notice 2025-69, which provides safe-harbor and alternative substantiation methods for taxpayers. The IRS acknowledged that 2025 information returns (including Forms W-2 and 1099) will not yet include separate reporting boxes for qualified tips or qualified overtime.

For employers and payors, Notice 2025-62 provides penalty relief under IRC §§6721 and 6722 for 2025 reporting failures while systems are updated for future years.

Comparison Table – IRC §224 and IRC §225

Qualified Tips Deduction

Eligibility and Scope

• Tip deduction is available to taxpayers who receive qualified tips in the list of occupations that the IRS has defined as “customarily and regularly receive tips” as of December 31, 2024.
• Qualified tips are voluntary cash or charge tips that are received from customers or through a tip-sharing arrangement. However, mandatory service charges or auto-gratuities generally do not qualify.
• Maximum deduction: $25,000 annually for single filers; phase-out begins at MAGI over $150,000 ($300,000 joint).
• The deduction is above the line — available to both itemizing and non-itemizing taxpayers.

Substantiation for 2025

Since Forms W-2 and Form 1099 for 2025 will not have dedicated boxes for qualified tips or overtime, the IRS allows for alternative reasonable methods. Taxpayers may rely on:

• Form W-2, Box 7 of Form W-2 (Social Security tips)
• Total tips reported to the employer on 4070 or an internal employer system
• Voluntary employer reporting (Form W-2 Box 14 or a written statement) identifying qualified tips
• Any amount included as unreported tip income that is reported on Form 4137 (Unreported Tip Income) is included in income on the return.

Phase-Out

The $25,000 tip deduction begins to phase-out for taxpayers with a modified adjusted gross income (MAGI) over $150,000 for single taxpayers or $300,000 for married filing jointly. For each $1,000 above the threshold, the deduction is reduced by $100. The tips remain subject to payroll taxes and withholding taxes.

Example 1. Sarah, a restaurant server, received her 2025 Form W-2, which shows $18,000 in Social Security tips (Box 7); her MAGI is $60,000. Since she works in a tip-eligible occupation, she may deduct the full $18,000 as qualified tips (no phase-out applies).

Example 2. Bradley, a bartender, reported $22,000 in tips to his employer during 2025 (via internal tip logs) and later included an additional $3,000 of unreported tips on Form 4137. His W-2 Box 7 shows only $15,000. Under IRS safe harbor rules, Bradley may use $22,000 + $3,000 = $25,000 and deduct the full $25,000.

Qualified Overtime Compensation Deduction

Eligibility and Scope

• The deduction applies to qualified overtime compensation, overtime pay required under Section §7 of the Fair Labor Standards Act (FLSA)—the half-time portion of time-and-a-half.
• Maximum deduction is $12,500 for single filers, $25,000 for married filing jointly
• The deduction is above the line, available to both itemizing and non-itemizing taxpayers.

Substantiation for 2025

Because 2025 pay statements likely will not break out qualified overtime separately, the IRS allows reasonable alternative documentation, therefore taxpayers may rely on:

• Employer voluntary reporting (Form W-2, Box 14, or separate statement)
• If not reported, the taxpayer may use payroll records, time sheets, or other documentation to calculate the FLSA overtime premium

Taxpayers must isolate the premium portion only, not the total overtime wages.

Phase-Out

Same as for tips: deduction reduced by $100 for each $1,000 of MAGI above $150,000 for single taxpayers, $300,000 for married filing jointly.

Example 3. Emily, a warehouse employee, earns $22/hr. and works 120 overtime hours at $33/hr. The overtime premium is $11/hr. x 120 hours, totaling $1,320. Her MAGI is $85,000; therefore, the full $1,320 is deductible.

Example 4. Daniel, a factory worker, earns $160,000 MAGI and has $15,000 in overtime during 2025. The maximum deduction is capped at $12,500, but if MAGI exceeds $150,000, the deduction is reduced by $1,000 due to the phase-out. Therefore, Daniel may deduct $11,500.

Transition Relief & Employer Reporting

For tax year 2025, the IRS is treating the new reporting rules as a transition period. Under Notice 2025-62, the IRS will not penalize employers or payors for failing to separately report qualified tips, qualified overtime compensation, or occupation codes on Forms W-2, 1099, statements, etc., as required by OBBBA — provided the rest of the return/statement is complete and correct.

Key Takeaways

• Qualified tips deduction- Up to $25,000 annually for single filers, phase-out begins at MAGI over $150,000 ($300,000 joint).
• Qualified overtime deduction- Up to $12,500 for single filers ($25,000 joint), same phase-out rules as tips.
• Both deductions are above-the-line and available whether or not the taxpayer itemizes.
• For 2025, Forms W-2 and 1099 will not have dedicated boxes; use IRS safe-harbor methods.
• Maintain detailed records of tips and overtime and prepare for new reporting requirements in 2026.
• Phase-out reduces deduction by $100 for every $1,000 of MAGI above the threshold.
• Tips and overtime remain subject to payroll taxes and withholding.

Practical Considerations for Tax Practitioners

• Confirm occupation eligibility: Advise clients to verify that their work is eligible based upon the IRS-listed tip-eligible occupations (as of December 31, 2024).
• Document tip receipts: Encourage clients to maintain contemporaneous tip logs, employer reporting records, and internal systems documentation.
• Ensure proper overtime classification: Ensure the taxpayer is non-exempt under the FLSA and that overtime is reflected as an actual premium.
• Track MAGI carefully: Phase-outs can significantly reduce the deduction, so planning around MAGI may be advisable.
• Retain payroll records: These may be essential for substantiating 2025 deductions, especially when employer reporting is incomplete.
• Plan for 2026 and beyond: Employers should begin preparing payroll systems for new reporting fields and employee communication.

Sources

• Treasury, IRS provide guidance for individuals who received tips or overtime during tax year 2025 | Internal Revenue Service
• Guidance for Individual Taxpayers who received Qualified Tips or Qualified Overtime Compensation in 2025 | Internal Revenue Service
• IRS announces no changes to individual information returns or withholding tables for 2025 under the One, Big, Beautiful Bill Act | Internal Revenue Service 
• Treasury, IRS issue guidance listing occupations where workers customarily and regularly receive tips under the One, Big, Beautiful Bill | Internal Revenue Service
• Occupations That Customarily and Regularly Received Tips: Definition of Qualified Tips | Federal Register