Treasury, IRS Provide Guidance for Tax Year 2025 for Individuals Claiming Deductions for Qualified Overtime and Qualified Tips

Employer Requirements

As a reminder:

·       Employers and payors are not required to provide employees or payees with a separate accounting of qualified overtime and cash tip amounts as defined by the Act for tax year 2025.   

Note:   The term “cash tips” includes, for example, tips voluntarily received from customers that are paid in cash or charged and, in the case of an employee, tips received under any tip-sharing arrangement.   Mandatory service charges or automatic gratuities are not considered qualified tips. 

·       Employers and payors are also not required to provide employees or payees with information concerning whether the employer or payor is a specified service trade or business, nor are they required to provide tipped employees or payees with a specified Treasury tipped occupation code (TTOC) for tax year 2025.  

·       While not required, the IRS encourages employers and payors to provide employees and payees with an approximate separate accounting of qualified overtime and cash tips, an indication of whether an employee or payee received tips from a specified service trade or business, and the TTOC to assist employees and payees with filing claims for applicable deductions on their individual tax returns.  

Determining Cash Tips and Qualified Overtime

Limitations on the Deduction for Cash Tips  

The deduction for tips remains subject to all applicable limits, including a cap of $25,000 and a phase out of the deduction for taxpayers with modified adjusted gross income over $150,000 ($300,000 for joint filers).

The deduction for both employees and independent contractors is only available for tips received while working in an occupation that customarily and regularly received tips on or before Dec.  31, 2024. Beginning in 2026, companies will be required to include a worker's TTOC on their Form W-2 or Form 1099-series.

For 2025, individuals are responsible for confirming that tips were received while working in a qualifying occupation and are, therefore, eligible to be deducted. If an employer or payor chooses to voluntarily provide information on an individual's occupation, individuals may rely on that information.

The Notice also addresses the Act's general requirement that cash tips exclude any tips received by an individual in the course of a trade or business that is a specified service trade or business (SSTB), even if the individual's occupation would otherwise make them eligible for the deduction. In general, SSTBs are a trade or business where the principal asset is the reputation or skill of employees and/or owners.

The Notice provides a transition period, extending until January 1 of the calendar year following the issuance of final regulations on SSTBs. During this transition period, the IRS will treat tips as not being received from an SSTB as long as they were received while working in an occupation that customarily and regularly received tips on or before Dec.  31, 2024.

Claiming the Deduction for Cash Tips

To claim the deduction for cash tips on their individual income taxes, individuals must first determine their cash tip amount using one of the methods provided in the Notice.

Ultimately, claiming the deduction will depend on the information issued to individuals by their employer/payor.

If, for example, the individual received any of the following, then the individual may use this information to assist them in claiming any allowable deduction for cash tips on their 2025 federal tax return:

·       The total amount of tips reported in Form W-2, Box 7 for 2025 

·       The total amount of tips reported in 2025 by the employee to their employer on Form 4070 (Employee's Report of Tips to Employer) or any similar form used to report tips monthly to an employer 

·       A separate accounting of cash tip amounts in Box 14 of your Form W-2 (The Notice also states that employers may provide employees with a separate accounting of cash tips by utilizing Form W-2, Box 14, which is an addition to the methods previously provided in Notice 2025-62.)
 

·       A year-end pay statement with year-to-date amounts of cash tips

Note - Regardless of the method used to account for cash tips, an employee can also include any additional tips from Line 4 of 2025 Form 4137 (Social Security and Medicare Tax on Unreported Tip Income).

In all cases, individuals may want to consult a tax advisor for further guidance on how to prepare individual tax returns and claim any available deduction.

Limitations on the Deduction for Qualified Overtime

As a first step, the Notice advises individuals to determine whether they are covered under the Fair Labor Standards Act (FLSA) or whether they are "exempt." Individuals who are exempt from the FLSA are generally ineligible for overtime. Some general examples of FLSA-ineligible employees include certain salaried executives, administrative personnel, professional employees and highly compensated employees, as well as outside sales employees.  Review more information here.

While exempt employees may be eligible for overtime under state law or receive premium pay for other reasons, those amounts would not be considered qualified overtime under the Act.

For those who are covered under the FLSA, the deduction remains subject to all applicable limits, including a cap of $12,500 ($25,000 for joint filers) and a phase out of the deduction for taxpayers with modified adjusted gross income over $150,000 ($300,000 for joint filers).

Claiming the Deduction for Qualified Overtime 

The Notice acknowledges the guidance previously provided in Notice 2025-62 that employers and payors are not required to provide a separate accounting of qualified overtime for tax year 2025. Accordingly, the Notice states that all individuals should make a "reasonable effort" to determine if they are FLSA-eligible and, if so, the amount of their 2025 qualified overtime.

The Notice also provides guidance for individuals to help them determine their qualified overtime for 2025. To claim the deduction for qualified overtime on their individual income tax returns, individuals must first determine their qualified overtime amount using the methods provided in the Notice.  Ultimately, claiming the deduction will depend on the information issued to individuals by their employer/payor.

If, for example, the individual received any of the following, then the individual may use this information to assist them in claiming any allowable deduction for qualified overtime on their 2025 federal tax return:

·       A separate accounting of qualified overtime amounts in Box 14 of your Form W-2 

Note:   ADP TotalSource is unable to accommodate reporting overtime amounts in  W-2 Box 14.

·      A year-end pay statement with year-to-date amounts of qualified overtime

·       An accounting of FLSA overtime based on specific circumstances.
Under the FLSA, the overtime requirements are different for certain classes of employers and employees (exceptions).When these exceptions apply, the deduction is based on the overtime premium that is required to be paid under the applicable exception.