IRS Issues 2025 Guidance on Tip and Overtime Deductions

Understanding the Internal Revenue Service's (IRS’s) recent 2025 guidance on tip and overtime deductions is vital for service workers, hourly employees, small business owners, and freelancers who rely on variable income. These changes, created under the One Big Beautiful Bill Act (H.R. 1), allow qualifying workers to deduct a portion of their tips and overtime pay from federal taxable income for the first time. 

With final rules now in place for 2025 filings, it’s a good time to understand who qualifies, what counts toward the deduction, and how to prepare your documentation before tax season.

Key Highlights

• The IRS confirms workers can deduct qualified tips up to $25,000 and qualified overtime compensation up to $12,500 for single filers or $25,000 for joint filers.

• These deductions apply for tax years 2025 through 2028 and are retroactive to January 1, 2025.

• Only voluntary tips and the Fair Labor Standards Act (FLSA) overtime premium qualify. Mandatory service charges and state-mandated or voluntary overtime premiums do not.

• Employers have penalty relief for 2025 if they do not separately report tips and overtime on W-2 forms, but employees must keep strong documentation.

• The deduction phases out for higher-income taxpayers once modified AGI exceeds $150,000 for single filers or $300,000 for joint returns.

• Updated IRS forms may lag behind these new rules, which means manual calculations may be required during the 2025 filing season.

Overview of the 2025 IRS Guidance

New IRS guidance issued formally expands two significant deductions created under the One Big Beautiful Bill Act: 

• The qualified tips deduction

• The qualified overtime pay deduction

The One Big Beautiful Bill Act tips overtime rules apply beginning with the 2025 tax year and extend through 2028. Workers who receive eligible tip income or required overtime premiums may now reduce their federal taxable income by these amounts.

The Act, which took effect January 1, 2025, was designed to support service workers and hourly employees who customarily and regularly receive tips. It introduced new opportunities for workers across industries like:

• Restaurants

• Hospitality

• Retail

• Home services

According to the IRS, taxpayers, including self-employed individuals, can reduce their income by the amount of qualified tips or qualified overtime compensation they receive. This is subject to the maximum annual deduction limit of $25,000. 

This four-year window gives workers time to adjust their record-keeping and payroll procedures. It also gives employers and accountants time to update their systems so employees can accurately claim deductions.

Who Qualifies for Tips and Overtime Eligibility

Review the following section to understand who qualifies for the IRS tip deduction 2025 (no tax on tips) and the IRS overtime deduction 2025 (no tax on overtime).

What Counts as Qualified Tips

The IRS defines qualified tips as voluntary tips received directly from customers, whether in cash or by credit card. These do not include mandatory service charges or gratuities imposed by the employer. Typical examples of eligible tips include:

• Cash tips from customers

• Credit or debit card tips

• Tips received through pooling arrangements

• Digital payment app tips when voluntarily given

To qualify, the taxpayer must work in an occupation that customarily and regularly receives tips. An official IRS tip and overtime deductions list covering 68 such occupations will be published. While that list is forthcoming, industries like restaurants, salons, hospitality, and delivery services will likely be included.

Employees and certain self-employed workers may qualify, though some self-employed service providers may be ineligible depending on their business classification. Workers can deduct up to $25,000 of qualified tips per year.

What Counts as Qualified Overtime Compensation

The overtime deduction only applies to the portion of overtime pay required under the FLSA. This is the extra half-time premium workers earn when they receive time and a half. Only the premium portion qualifies, not the entire overtime payment.

Examples of overtime that do not qualify:

• Voluntary or discretionary overtime rates

• Overtime required only by state or local law

• Double-time arrangements

• Employer-paid overtime premiums beyond FLSA requirements

For 2025, the deduction limit is $12,500 for single filers and $25,000 for joint filers. This provides meaningful relief to workers in industries where overtime hours are frequent or seasonal.

How to Claim the Deductions for Tax Year 2025

What If Your Employer Doesn’t Separate Tips or Overtime on W-2 or 1099 Forms

Because these deductions apply for the first time this year, the IRS is providing transition relief for employers. Many will not yet have payroll systems capable of reporting tips and overtime separately. Employers will not face penalties during 2025 if they fail to report the amounts individually.

This relief does not remove the burden from employees. Workers must use their own records to calculate the amount eligible for the deduction. Acceptable documentation includes:

• Pay stubs

• Employer statements

• Point-of-sale tip records

• Tip diaries or logs

• Timekeeping and overtime reports

• Other specified statements

This makes record-keeping more critical than ever. Workers should retain all pay information for the entire year to substantiate any deductions taken at filing time.

Phase-outs and Income Limits

The Act includes income-based phase-outs. Taxpayers with modified adjusted gross income above $150,000 for single filers or $300,000 for joint filers will see the deduction reduced or eliminated.

Workers in higher-income brackets will need to review their eligibility based on their year-end income.

When to Expect Updated Income Tax Forms and What 2025 Filing Will Look Like

The IRS is in the process of updating forms and instructions to accommodate these new deductions. However, official tip and overtime guidance for employees indicate that the 2025 filing season may require manual calculations. Some forms may not fully reflect the updates until later years, which means taxpayers and businesses should be prepared to calculate the deduction amounts themselves.

This could affect payroll withholdings and tax planning, especially for workers who are accustomed to automatic withholding adjustments. Employers should keep this in mind as they prepare for 2025 year-end reporting.

What This Means for Workers and Businesses

For Tipped Employees (Restaurants, Hospitality, Gig Workers, etc.)

Tipped workers can reduce taxable income by up to $25,000 of qualified tips. Those potential tax savings could be significant for servers, bartenders, rideshare drivers, hospitality staff, salon professionals, and other specified service trade workers. To take advantage of this tax deduction, workers should:

• Track all tips, whether cash or electronic

• Maintain daily tip logs

• Retain pay stubs and payroll documentation

• Understand which payments count as tips and which do not

Some self-employed individuals may also benefit if they meet IRS requirements. This varies by industry and business structure.

For Overtime-Eligible Employees

Workers who regularly receive FLSA-required overtime compensation may be able to deduct the premium portion of their overtime pay. This will be especially helpful for workers in shift-based industries, including: 

• Healthcare

• Logistics

• Manufacturing

• Retail

Only the premium portion of the income is deductible, so workers must track their hours accurately.

For Small Business Owners and Employers

While employers receive penalty relief for the 2025 tax year, this is temporary. Beginning in 2026, employers will need to report tips and qualified overtime amounts separately on Form W-2. Updating payroll systems early can prevent compliance issues later.

Businesses should consider:

• Reviewing payroll and timekeeping systems

• Training staff on proper tip reporting procedures

• Ensuring overtime premiums are classified accurately

• Consulting with a payroll accountant or tax professional

This is also an opportunity for businesses to streamline their bookkeeping. If your company handles a significant amount of tipped or overtime work, professional support can help prevent errors and reduce audit risk. The 1-800Accountant team can assist your business with customized payroll solutions and bookkeeping support to ensure you're ready for these changes.

Key Caveats and What’s Still Unclear

Although the new rules are clear in most areas, several uncertainties remain as the IRS finalizes its systems:

• The official list of eligible tipped occupations has not yet been published. Workers in borderline industries should monitor IRS updates.

• Voluntary overtime or state-mandated overtime beyond FLSA requirements is not eligible.

• Tips remain subject to Social Security and Medicare taxes even though they may be deductible from federal income tax.

• Because 2025 forms may not fully reflect the new deductions, taxpayers should expect to use additional worksheets or perform manual calculations when filing.

As guidance continues to evolve, workers and business owners should stay informed to make the most of available tax benefits.

Action Steps for 1-800Accountant Clients and Readers

To prepare for the 2025 tax year, workers and business owners should take proactive steps now:

• Start gathering records of tips, overtime hours, and employer pay statements.

• Keep consistent tip logs and payroll stubs throughout the year.

• Review employee classifications to ensure they align with occupations that regularly receive tips.

• Consider updating payroll systems before 2026 when employer reporting requirements take effect.

• Seek support from a tax professional who understands these rules and can help you document eligible deductions correctly.

When you need guidance on tracking tips, calculating overtime, or preparing for the 2025 filing season, the team at 1-800Accountant is ready to help.

What This Means in the Bigger Picture

The introduction of tip and overtime deductions under the One Big Beautiful Bill Act marks a significant shift in how service and hourly workers report income. For many Americans, this change provides an opportunity to lower taxable income and keep more of what they earn. However, the new rules also place additional responsibility on workers to maintain good documentation and understand which payments qualify.

As the IRS continues to update forms and instructions, the 2025 filing season may require more involvement from individual taxpayers and employers than in previous years. With strong planning and the right support, workers and businesses can navigate the transition smoothly and take full advantage of the available deductions.

For personalized help with these new rules or other tax questions, connect with the team at 1-800Accountant, America's leading virtual accounting firm. We’re here to support your success throughout the year. Schedule a free 30-minute consultation to learn more about the benefits of our affordable, tax-deductible financial services.