Taxpayers who depend on tips and overtime have faced a recurring problem every filing season: income records rarely match how that money is actually earned, and the tax code has not met workers where they are until now, when two new deductions give practical relief while insisting on documentation that fits real pay systems and real jobs. Under the One Big Beautiful Bill Act, the IRS has implemented the “No Tax on Tips” and “No Tax on Overtime” deductions as deductions from income rather than exclusions, preserving the integrity of wage reporting while reducing taxable income when workers can substantiate qualified tips or the premium half of federally required overtime. The agency’s approach acknowledges that most employers, platforms, and payroll processors do not yet isolate the necessary amounts on Forms W-2, 1099, or platform statements, so it accepts reasonable reconstruction with records already in people’s hands. The guidance, published in Notice 2025-69 and related employer materials, also coordinates phase-outs, caps, and joint-filing rules to keep the benefit targeted, and it aligns overtime strictly with the Fair Labor Standards Act to establish one national standard. Together, these features mark a pivot to clarity without forcing payroll systems to retool overnight.
what’s new in 2025
overview of the two deductions and transition relief
Two deductions define the moment. The first covers qualified tips up to $25,000 a year, and it reaches both employees and self-employed workers in occupations the IRS identifies as customarily tipped as of December 31, 2024. The second lets eligible workers deduct only the “half” premium mandated by the Fair Labor Standards Act for overtime, capped at $12,500 for single filers and $25,000 for joint filers. The policy choice to make these deductions from income, not exclusions, keeps wage reporting intact while offering tangible relief that does not depend on itemizing. Both are temporary, running from 2025 through 2028, and both share guardrails that include income-based phase-outs, Social Security Number requirements, and a joint-filing condition for married taxpayers. The IRS emphasizes that the same dollars cannot be counted twice, a point that avoids confusion when tips and overtime appear on the same paychecks.
Transition relief makes this first year workable. Because 2025 payroll and platform systems largely do not isolate qualified tips or the FLSA overtime premium, the IRS accepts “reasonable methods” to compute eligible amounts. For tips, that includes W-2 Box 7 (Social Security tips), tip reports provided to an employer, daily logs, and Form 4137 for unreported tips; for self-employed workers, contemporaneous logs and similar records fill the gap when 1099-K forms do not break out tips. For overtime, pay stubs and employer records are central, and when the premium portion is not separately identified, simple math isolates the deductible premium from total overtime pay. The agency pairs this flexibility with clear examples and cautions against double counting, signaling that good records will be enough even if boxes and lines on information returns lag behind the law.
who is affected and key limits
The deductions aim squarely at workers who regularly receive tips or who work overtime covered by federal law, but they are not open-ended. Modified adjusted gross income above $150,000 for single filers or $300,000 for joint filers triggers phased reductions that ultimately eliminate the benefit, and married taxpayers must file jointly to claim either deduction. A valid Social Security Number is required, a safeguard that aligns with identity rules already embedded throughout the tax system. Notice 2025-69 consolidates taxpayer-facing guidance, and a companion document for employers explains what is expected this year on wage statements and in payroll systems, including the reality that many forms will not break out precise amounts.
What stands out is how the IRS aligns eligibility with existing legal frameworks rather than ad hoc labels. For overtime, FLSA coverage is the defining threshold, which distinguishes federally mandated premiums from pay practices that arise under state law or employer policy alone. For tips, the agency ties the universe of eligible workers to an occupations list that is being formalized through regulations, ensuring that “customarily and regularly tipped” has a concrete meaning. The caps—$25,000 for tips, and $12,500 or $25,000 for overtime depending on filing status—set generous but finite boundaries. By previewing form redesigns and withholding changes for 2026, the IRS also acknowledges that today’s reasonable-methods approach is a bridge, not a permanent feature, and that more precise reporting will be the norm in the next filing cycle.
“No Tax on Tips” Deduction
eligibility and core limits
Eligibility begins with the nature of the work. Employees and self-employed individuals in occupations the IRS classifies as “customarily and regularly tipped” as of December 31, 2024, can claim the deduction for qualified tips they actually earned. The definition of qualified tips follows long-standing rules: they must be voluntary amounts from customers, whether paid in cash or by card, and tips received through pooling or sharing arrangements count if they are properly reported. Workers who use Form 4137 to report unreported tips for FICA and Medicare purposes can include those amounts when computing the deduction, which is capped at $25,000 each year. Self-employed taxpayers face an additional guardrail: the deduction cannot exceed the net income from the trade or business that generated the tips, calculated before applying this deduction, a limit that prevents the deduction from creating or enlarging a loss.
Special treatment applies to specified service trades or businesses. As a broad rule, SSTB involvement excludes otherwise qualified tips for self-employed workers and for employees whose employer is an SSTB, reflecting a policy choice to limit benefits to non-SSTB contexts. However, the IRS acknowledged that final regulations are still in flux and extended transition relief for this year, allowing some tips tied to SSTBs to be treated as qualified on a case-by-case basis if they meet the law’s other requirements. That relief gives taxpayers a workable path while the regulatory picture is finalized. Phase-outs based on modified AGI further narrow the deduction as income rises above $150,000 for single filers and $300,000 for joint filers, and married taxpayers must file jointly and provide a valid SSN. These intertwined rules set clear expectations: eligibility turns on occupation, documentation, and income thresholds, not on informal job titles or ad hoc practices.
documentation rules for 2025
Documentation drives the tips deduction this year because most W-2s will not isolate qualified tips beyond existing fields. The IRS accepts W-2 Box 7 as a starting point for employees when that box reflects Social Security tips reported to the employer; if there are no unreported tips on Form 4137, the Box 7 amount may serve as the qualified total. Where unreported tips exist, Form 4137 fills the gap, and the worker may either use Box 7 or the aggregate of tips reported to the employer on Forms 4070, then add the Form 4137 amount. Employer-provided breakdowns, when offered voluntarily, are also acceptable, though not required. Because third-party payment networks do not separate tips on 1099-K forms this year, self-employed workers are encouraged to maintain contemporaneous tip logs, daily summaries, or similar records that show dates, amounts, and business context. The agency’s guidance favors documentation that already exists within normal payroll and bookkeeping routines.
The standard is “reasonable methods,” not rigid formulas. That phrase matters because it acknowledges that restaurants, salons, ride-share platforms, and event contractors track tips differently, and workers may be paid through various channels within a single month. A server who receives cash tips, pooled tips, and card tips routed through the employer can reconcile those streams through daily or shift-level records and employer reports, while a self-employed guide can rely on logged gratuities tied to bookings that were paid by card processors that lack a tips tag. The IRS’s examples show that a consistent method, used throughout the year and rooted in available records, is sufficient. The key is internal consistency and the ability to demonstrate how totals were derived. That approach balances flexibility with accountability, giving taxpayers confidence that ordinary records—W-2 Box 7, Forms 4070, pay stubs, tip logs, Form 4137—meet the standard.
how the IRS examples work in practice
The IRS examples demonstrate the intended simplicity. Take a waiter whose W-2 shows Social Security tips in Box 7 and who did not use Form 4137 for unreported tips. In that case, the Box 7 number can be treated as qualified tips for the deduction, subject to the $25,000 cap and any phase-out. The logic is straightforward: Box 7 reflects tips that were subject to Social Security tax and reported to the employer, which aligns with the documentation expectation for this year. In contrast, a bartender who filed Form 4137 because some tips were not reported to the employer can choose a base. The bartender may start with Box 7 or with the total reported to the employer on Forms 4070, and then add the Form 4137 amount, yielding a complete tally that captures both reported and unreported tips that have now been brought into the system.
Self-employed workers illustrate the transition relief most vividly. A travel guide who collects gratuities through a platform will likely receive a 1099-K that bundles fares and tips in a single gross figure, with no separate tips flag. Under the reasonable-methods standard, daily logs that record gratuities by job, date, and client, supplemented by booking records and bank deposits, substantiate the tips portion and support the deduction up to the annual cap. The IRS did not insist on post hoc employer-style reporting for sole proprietors, recognizing that the platform economy does not yet deliver segregated tips data. That flexibility, paired with the cap and the requirement that the deduction cannot exceed net income from the activity, produces a practical outcome: taxpayers can claim relief using records they already maintain, and the agency can verify claims through documentation that fits real-world workflows.
“No Tax on Overtime” Deduction
who qualifies and what counts
Overtime brings its own complexity, so the IRS anchored the deduction in federal law. Only workers covered by the Fair Labor Standards Act’s overtime rules qualify, which means the deduction applies when the law requires at least time-and-a-half for hours worked over the applicable threshold, typically over 40 in a workweek. If a worker is not covered by the FLSA but receives overtime pay due to state law or employer policy, those amounts do not count, even if labeled “overtime” on a pay stub. The deductible portion is the FLSA premium—the “half” paid over the regular rate to reach time-and-a-half—not the entire overtime amount. This distinction matters when employers pay doubletime or a higher multiple: only the equivalent “half” required by federal law qualifies, and the extra incentive beyond that is outside the deduction.
The structure mirrors the tips deduction’s guardrails to keep the policy coherent. The cap is $12,500 for single filers and $25,000 for married filing jointly, the same phase-out thresholds apply at $150,000 and $300,000 of modified AGI, and married taxpayers must file jointly and provide a valid SSN. These conditions ensure that the benefit targets middle-income workers whose paychecks regularly include overtime premiums. Tying eligibility to FLSA coverage also creates a single national standard that avoids a patchwork driven by state rules and internal employer policies, which can vary widely. That choice makes payroll calculations consistent and prevents the deduction from morphing based on local labels. The IRS then uses reporting pragmatism for this year: where the premium is not separately identified, a simple fraction of total overtime can stand in for the deductible premium, provided the underlying rate conforms to time-and-a-half or doubletime.
calculating the deductible premium
The calculation is deliberately simple when the premium is not broken out on a pay stub. For standard time-and-a-half, total overtime pay consists of the regular-rate portion plus the “half” premium. Because that premium is one part out of three equal parts in the total (regular rate, regular rate, and the half premium), dividing total overtime pay by three isolates the deductible FLSA premium. If the employer pays doubletime, the overtime total includes the regular-rate component plus an additional full regular-rate premium and then another “half” to meet doubletime, but the deductible piece remains the same “half” that federal law requires to reach time-and-a-half. In that scenario, dividing total overtime pay by four isolates the FLSA “half” premium, while the extra compensation beyond that remains nondeductible. When a pay stub explicitly lists “overtime premium,” the stated amount controls and no division is needed.
The method holds for special cases that the FLSA treats uniquely. Certain public safety roles operate on longer work periods, but the concept is unchanged: when the total overtime compensation reflects time-and-a-half, one-third of that total is the FLSA premium and thus potentially deductible. Public-sector workers who bank comp time and later receive a cash-out also rely on the same principle, treating one-third of the payout as the qualifying premium when the underlying scheme mirrors time-and-a-half. The IRS guidance underscores that clarity is preferable to precision that workers cannot obtain from current pay systems. Employers and payroll processors may not reprogram systems midyear to expose the premium component, so simple fractions provide a reasonable estimate that will be replaced by precise reporting in the next filing cycle. The result is a rule that workers can apply without chasing bespoke spreadsheets or recalculating hourly rates for every pay period.
IRS example scenarios
The examples translate theory into manageable steps. If a pay stub cleanly identifies the overtime premium—say, $5,000 over the year—that $5,000 is the candidate for the deduction, subject to the cap and any phase-out based on modified AGI. In that setting, the employee’s records and the employer’s payroll output align, making the computation and substantiation straightforward. If, instead, the stub shows only a single overtime line totaling $15,000 for hours compensated at time-and-a-half, dividing by three isolates the deductible premium, yielding $5,000. This approach assumes that the employer correctly applied time-and-a-half to hours above the FLSA threshold, so the worker does not need to reconstruct the regular rate across variable weeks to find the premium.
A similar logic applies to doubletime. If a worker logs $20,000 of overtime paid at doubletime with no separate premium line, dividing by four isolates the FLSA “half” premium for a $5,000 deduction candidate, with the rest treated as nondeductible compensation beyond federal requirements. The IRS extends the same math to special FLSA work periods used by law enforcement and certain public employers: where overtime is functionally time-and-a-half, one-third reveals the deductible premium. For comp time that is later cashed out, the one-third rule applies to the payout when it is structured to reflect time-and-a-half equivalents. These examples, coupled with the agency’s insistence on reasonable methods for this year, show that ordinary pay stubs and employer records, plus simple arithmetic, are enough to capture the qualifying premium without engineering new reporting infrastructures overnight.
coordination, filing, and what to watch
no double-dipping and interaction with other rules
Coordination rules prevent overstatement. The IRS makes clear that the same wage dollars cannot be counted twice; tips are not overtime, and overtime is not tips, even if both appear on the same check. These deductions affect only income tax calculations and leave FICA and Medicare treatment untouched, so Form 4137 still governs unreported tips for payroll tax purposes. That separation keeps the wage base for Social Security consistent and avoids downstream mismatches with earnings records. It also means the new deductions do not alter withholding obligations for Social Security and Medicare, which continue to apply to tip income and overtime pay as before.
Recordkeeping is the practical anchor. Workers who keep W-2s, Forms 4070, Form 4137 if used, pay stubs, employer summaries, and tip logs will have what they need to support their claims. Self-employed workers should preserve contemporaneous logs and transaction-level detail that tie gratuities to clients and dates, which will stand in for absent 1099-K tips data this year. For overtime, maintaining pay stubs that show hours, rates, and any separate premium line streamlines the process; when such a line is absent, the division rules allow a reasonable calculation that aligns with the FLSA framework. These coordination points place emphasis on internal consistency as much as on external labeling, ensuring that taxpayers do not inadvertently overlap amounts across the two deductions or across income and payroll tax regimes.
how to claim on your return
Claiming the deductions is centralized on a new form. Taxpayers filing returns for this year will use Schedule 1-A, Additional Deductions, to report both “No Tax on Tips” and “No Tax on Overtime,” alongside two other OBBBA deductions not covered here. The IRS has released a draft and is updating instructions, but the core mechanics are already plain: report income as usual on wage and business schedules, then take the deductions on Schedule 1-A to reduce adjusted gross income. This structure keeps wage reporting complete and allows the deductions to benefit both itemizers and non-itemizers. It also creates a single location for the temporary OBBBA deductions, making the filing experience more coherent for taxpayers and software providers alike.
Substantiation rides with the forms. Workers should keep W-2s that show Box 7 for Social Security tips, Forms 4070 provided to employers, Form 4137 if filed, and any employer estimates or breakdowns offered voluntarily. Self-employed workers should retain tip logs and transaction records that support the tips amount; on the overtime side, pay stubs and employer records that display overtime hours, rates, and premium lines are ideal. Where stubs do not separate the premium, include the calculation used—dividing by three for time-and-a-half, by four for doubletime—and maintain the underlying pay records in case of questions. These documentation habits serve a dual purpose: they support the deduction today and prepare taxpayers for next year’s more structured reporting, when updated forms are expected to capture separate totals without reconstruction.
2026 reporting changes and action steps now
The IRS has set the stage for cleaner reporting next year. Redesigned W-2s, revised withholding tables, and updated instructions are expected to identify qualified tips and the overtime premium more precisely, reducing reliance on reasonable-methods estimates and manual math. Employers and payroll providers will have clearer specifications, and third-party settlement organizations are expected to adapt statements to flag tips distinctly where feasible. That arc matters because it shortens the distance between what happens in a workplace and what appears on a tax form. In turn, compliance becomes faster and less error-prone, and audits can focus on the substance of claims rather than on whether a field existed to capture them. Until those changes arrive, the message is continuity: keep using the records already available and apply the straightforward calculations the IRS endorsed.
Action steps already stood out for anyone planning a return. Workers verified that their occupations appear on the IRS tipped-occupation list as of December 31, 2024, or that their roles are covered by FLSA overtime rules, and they assembled records that reflect those realities. They tracked modified AGI to anticipate phase-outs, chose consistent methods to compute qualified amounts, and kept calculation notes next to pay stubs and logs. Self-employed taxpayers leaned on daily tip logs and booking records when 1099-Ks lacked a tips line, while employees reconciled W-2 Box 7, Forms 4070, and Form 4137 entries where needed. By the end, the path forward had been clear: claim both deductions on Schedule 1-A, avoid double counting, respect caps and income thresholds, and expect the process to become simpler when updated forms and withholding guidance took hold in the next cycle.
