On November 21, 2025, the Department of the Treasury and the Internal Revenue Service (IRS) jointly issued Notice 2025-69, providing crucial guidance for individual taxpayers eligible to claim new federal income tax deductions for qualified tips and qualified overtime compensation for the 2025 tax year. These new provisions were introduced by Public Law 119-21, 139 Stat. 72 (July 4, 2025), commonly referred to as the One, Big, Beautiful Bill Act (OBBBA).

The OBBBA added new Code Section 224, granting an income tax deduction for "qualified tips," and new Code Section 225, granting an income tax deduction for "qualified overtime compensation". Both deductions are available for tax years beginning after December 31, 2024, and ending before January 1, 2029. The IRS is currently updating income tax forms and instructions to facilitate the claiming of these deductions during the filing season.

Rationale for Issuance of Guidance

The primary impetus for issuing Notice 2025-69 stems from the phased implementation of the OBBBA’s new information reporting requirements. The OBBBA revised several information reporting provisions (including Code Sections 6041, 6041A, 6050W, and 6051) to require employers and payors to separately account for cash tips and qualified overtime compensation on statements furnished to individuals, such as Form W-2 and various Form 1099s.

However, the IRS previously announced (IR-2025-82) that the 2025 versions of Form W-2, Form 1099-NEC, Form 1099-MISC, and Form 1099-K will not be updated to include this new separate accounting for tips or qualified overtime. The forms are slated for updates in tax year 2026.

Due to the absence of the required separate reporting on 2025 forms, the Notice was necessary to instruct individual taxpayers on how to satisfy the requirements for the deductions, specifically addressing how to determine the amount of qualified tips or qualified overtime compensation for tax year 2025. The Notice also provides transition relief regarding certain requirements.

IRS Analysis of the Law: Qualified Tips (Code Section 224)

The deduction under Code Section 224(a) is available to individuals who received qualified tips in an occupation that customarily and regularly received tips on or before December 31, 2024.

Deduction Limits and Qualifications

The maximum annual deduction is $25,000. This deduction is subject to a phase-out if the taxpayer’s Modified Adjusted Gross Income (MAGI) exceeds $150,000 ($300,000 for joint filers). MAGI is defined as the taxpayer’s adjusted gross income increased by any amount excluded under Section 911, Section 931, or Section 933.

For married individuals (within the meaning of Section 7703), the deduction is only available if they file a joint return for the taxable year. Furthermore, the deduction is conditioned on the taxpayer including their social security number on the tax return (Code Section 224(e)).

Qualified tips must satisfy several specific requirements (Code Section 224(d)(2)):

The payment must be made voluntarily without consequence for nonpayment, not be the subject of negotiation, and be determined by the payor.
The amount must be a "cash tip," which includes tips received from customers paid in cash or charged, and, for employees, tips received under any tip-sharing arrangement.
The tips must not be received in the course of a trade or business that is a specified service trade or business (SSTB) as defined in Code Section 199A(d)(2).

SSTB Restriction for Employees and Transition Relief

The application of the SSTB restriction is defined by Code Section 224(d)(2): an employee receiving tips is treated as receiving them in the course of an SSTB if the trade or business of the employer is an SSTB. For non-employees, Code Section 224(c) provides that tips received in the course of a non-employee trade or business are only taken into account under Section 224(a) to the extent that the gross income for the business (including the tips) exceeds the sum of the deductions allocable to the business.

Recognizing that many small businesses have not previously had to determine their SSTB status under Section 199A, and that employees and non-employees face difficulty determining eligibility based on employer status, the IRS issued transition relief for the SSTB requirement.

For purposes of IRS enforcement and administration, the transition period lasts until January 1 of the first calendar year following the issuance of final regulations regarding the SSTB determination for Section 224. During this transition period, the IRS will treat the individual as having received tips in the course of a trade or business that is not an SSTB, provided the employee is in an occupation that customarily and regularly received tips on or before December 31, 2024.

IRS Analysis of the Law: Qualified Overtime Compensation (Code Section 225)

Code Section 225(a) provides a deduction for qualified overtime compensation. This compensation must be the amount paid in excess of the regular rate at which the individual is employed and must be required under Section 7 of the FLSA (29 USC Section 207).

Deduction Limits and Qualifications

The maximum annual deduction for qualified overtime compensation is $12,500 ($25,000 for joint filers). This deduction is also subject to the MAGI phase-out threshold of $150,000 ($300,000 for joint filers). The deduction is available to both itemizing and non-itemizing taxpayers.

Similar to the tip deduction, the deduction requires the inclusion of the taxpayer’s social security number (Code Section 225(d)) and requires married taxpayers to file jointly (Code Section 225(e)).

FLSA Requirement

The deduction applies only to the FLSA-required premium. Since the FLSA generally requires employees to be paid not less than one and one-half times their regular rate for hours worked over 40 in a workweek, the qualified amount is generally the "half" portion of "time-and-a-half" compensation.

Payments that exceed the FLSA-required premium, such as when an employer voluntarily pays double time, are not qualified overtime compensation under Section 225. Furthermore, only overtime compensation paid to an individual who is both covered by and not exempt from the FLSA (an FLSA-eligible employee) qualifies under Section 225(c). Overtime compensation paid to an FLSA-ineligible employee is not qualified overtime compensation.

Application of the Law and Procedure for Tax Year 2025

Qualified Tips Calculation for Employees

For tax year 2025, since Form W-2 does not separately account for cash tips as required by Code Section 6051(a)(18), the IRS treats the deduction requirement of Section 224(a) as satisfied if the employee’s cash tips are properly reported on the Form W-2. Employees may calculate qualified tips (subject to MAGI and dollar limits) using the following amounts:

The total amount of social security tips reported in box 7 of Form W-2.
The total amount of tips reported by the employee to the employer on all Forms 4070, Employee’s Report of Tips to Employer (or any similar substitute).
If an employer voluntarily reports the employee’s cash tips in box 14 of Form W-2 or on a separate statement, that amount may be used.

In addition to the amount determined using one of the three options above, employees may also include any amount listed on line 4 of the 2025 Form 4137 (Unreported Tip Income).

For example, Ann, a restaurant server, had $18,000 of social security tips in Form W-2 box 7 and reported no additional tips on Form 4137. Ann may use $18,000 in determining her qualified tips.

Alternatively, Bob, a bartender, had $15,000 in Form W-2 box 7, but reported $20,000 in tips to his employer on Forms 4070. Bob also reports $4,000 of unreported tips on Form 4137, line 4. Bob has the option of using either the $15,000 from box 7 or the $20,000 from the Forms 4070, and may additionally include the $4,000 from Form 4137.

Qualified Tips Calculation for Non-Employees

For non-employees (such as independent contractors), the 2025 Forms 1099 (MISC, NEC, K) will not separately account for cash tips, failing to meet the requirements of Code Sections 6041(d)(3), 6041A(e)(3), or 6050W(f)(2). Therefore, the IRS treats the separate accounting requirement as satisfied if the non-employee’s cash tips are included in the total amounts reported on the applicable Form 1099.

Non-employees must determine the amount of qualified tips (subject to other requirements, including the business income limitation under Section 224(c)) using earnings statements or other documentation such as daily tip logs, receipts, point-of-sale system reports, or third-party settlement organization records that corroborate the total tip amount.

For example, Doug, a self-employed travel guide, received $7,000 in tips via a Third-Party Settlement Organization (TPSO), included in a total payment of $55,000 shown on Form 1099-K. Because Doug kept daily tip logs substantiating the $7,000, he may use this amount in determining his qualified tips.

Qualified Overtime Compensation Calculation

Since 2025 forms may lack the required separate accounting for qualified overtime compensation (Code Sections 6051(a)(19) and 6041(d)(4)), the requirement is treated as satisfied if the compensation is properly reported on the individual’s income statement (Form W-2 or 1099).

If the employer does not provide the qualified overtime amount in Box 14 of Form W-2 or on a separate statement, the FLSA-eligible employee must use other documentation, such as pay statements or invoices, and apply a reasonable method to determine the FLSA Overtime Premium.

Reasonable Methods for Determining Qualified Overtime Compensation in 2025:

Separate FLSA Premium: If the individual receives a statement covering 2025 that separately accounts for the FLSA Overtime Premium (the “half” portion of time-and-a-half), the individual may use that specific amount. For instance, if Individual A’s payroll system shows $5,000 as the “overtime premium,” Individual A may include $5,000.
Aggregate Time-and-a-Half: If the statement shows the aggregate dollar amount combining the FLSA Overtime Premium and the regular wages for the hours over 40 (i.e., the total time-and-a-half amount), the individual may use one-third of that aggregate dollar amount. For example, if Individual A’s pay stub shows total “overtime” of $15,000, the qualified amount is $5,000 ($15,000 divided by 3).
Higher Overtime Rate (Premium Separated): If the employer pays a rate higher than time-and-a-half (e.g., double time), and the statement separately accounts for the amount in excess of the regular rate, the individual must multiply that amount by an appropriate fraction to approximate the FLSA Overtime Premium (e.g., if paid double time, multiply by one-half).
Higher Overtime Rate (Aggregate Amount): If the employer pays a higher rate (e.g., double time) and the statement shows the aggregate dollar amount of that overtime (premium plus regular wages portion), the individual must multiply that aggregate amount by an appropriately smaller fraction. For example, if Individual B’s total overtime amount is $20,000 paid at double time, the qualified amount is $5,000 ($20,000 divided by 4).
Alternative FLSA Rules: If the employer satisfies FLSA requirements via alternative subsections (such as Section 207(k) for law enforcement or Section 207(o) for compensatory time), the individual must compute the amount by operation of those specific overtime rules and may use any reasonable method in the Notice that takes the alternative rules into account. For example, Individual C, law enforcement paid $15,000 of total overtime under Section 207(k), may include $5,000 ($15,000 divided by 3).

Necessary Taxpayer Actions for 2025 Returns

Tax professionals should advise clients that the IRS is updating 2025 tax forms and instructions (including Form 1040) to incorporate these new deductions.

The fundamental requirement for claiming these deductions remains the substantiation of eligibility and amount. Taxpayers must maintain adequate books and records to satisfy the requirements under 26 CFR Section 6001-1. This includes retaining Forms 4070 (or equivalent reports), daily tip logs, payroll statements, earnings statements, and any separate statements provided by the employer or payor regarding tips or overtime.

For taxpayers who have received qualified tips, they should rely on the transition relief provided by the Notice regarding the SSTB restriction, treating the tips as not received in the course of an SSTB, provided their occupation is generally eligible for tips.

The complexity of calculating qualified overtime compensation for 2025, especially where payroll systems do not separate the FLSA premium, necessitates careful review of pay stubs and application of the reasonable methods detailed in the Notice. Individuals who had multiple employers during 2025 may apply different methods for calculating qualified overtime compensation for each employer.

The structure of the new deductions, requiring careful documentation and specific calculations based on FLSA definitions, is akin to deciphering a complex wage contract where only the federally mandated minimum premium (the "half") can be extracted and utilized as a non-taxable benefit, regardless of how much higher the total payment may appear on the face of the earnings statement.

Prepared with assistance from NotebookLM.