IRS Announces 2025 Transition Guidance for the Tips and Overtime Deductions
Pro-taxpayer guidance will permit tip deductions prohibited by statute
In Notice 2025-69, the IRS announced the full scope of transitional relief for claiming the new §224 qualified tips deduction and the new §225 qualified overtime deduction.
Understanding this guidance is essential for tax professionals claiming these deductions on 2025 tax returns.
Read this prior edition for an overview of the tips and overtime deductions.
Prior Transition Relief
The IRS previously announced that there would be no changes to information returns for tax year 2025, which complicates the claiming of these deductions, as taxpayers cannot rely on direct third-party information reporting to claim deductions.
Tips Deduction Guidance for Employees
To determine qualified tips for 2025, an employee in a qualifying occupation can use one of three methods:
Use the amount in box 7 on Form W-2,
Use the amounts reported by the employee to the employer on all Forms 4070, Employee’s Report of Tips to Employer (or any similar substitute form), or
Use the box 14 reported amount (or separate statement) if the employer voluntarily chooses to report the qualified tips amount.
Employees may add to the above amount any amount listed on line 4 of the 2025 Form 4137, Social Security and Medicare Tax On Unreported Tip Income, filed with the employee’s 2025 income tax return.
Employees of §199A specified service trade or businesses (SSTBs) cannot claim the deduction with respect to those tips; however, the IRS is not enforcing that limitation for tax year 2025, provided the employee’s occupation is on the list of occupations that customarily and regularly received tips on or before December 31, 2024 in the §224 proposed regulations.
Tips Deduction Guidance for Self-Employed Taxpayers
To determine qualified tips for 2025, a non-employee in a qualifying occupation can use earnings statements or other documentation such as receipts, point-of-sale system reports, daily tip logs, third-party settlement organization records, or other documentary evidence that corroborates the calculation of the total amount of tips that are qualified tips.
However, the tip amounts claimed must be included in the total income reported on either Form 1099-K, Form 1099-NEC, or Form 1099-MISC; physical cash tips are not eligible for the tips deduction, even if properly reported as income.
§199A SSTBs cannot claim the deduction with respect to those tips; however, the IRS is not enforcing that limitation for tax year 2025, provided the non-employee’s occupation is on the list of occupations that customarily and regularly received tips on or before December 31, 2024 in the §224 proposed regulations.
The non-enforcement of the SSTB limitation for non-employees is puzzling; a self-employed taxpayer has had to make the determination of whether or not their business is an SSTB since 2018 when the §199A first became available.
Overtime Deduction Guidance
To qualify for the overtime deduction, an employee must be paid overtime under 29 U.S.C. §207 (generally on hours in excess of 40 in a work week, but there are other provisions in that section). Therefore, the employee must be both covered and non-exempt under the Fair Labor Standards Act.
An employee can use the box 14 reported amount (or separate statement) if the employer voluntarily chooses to report the qualified overtime compensation amount.
If the employer does not report the qualified overtime compensation amount, the employee can use other documentation, such as earnings or pay statements, invoices, or similar statements, using a reasonable method to determine the amount of the qualified overtime compensation. The guidance provides seven different methods an employee can use to determine the amount.
Example. Briana’s employer has a practice of paying overtime at a rate of two times an employee’s regular rate of pay. She was paid $20,000 in overtime pay under that practice, although 29 U.S.C. §207 only requires her employer to pay one-and-a-half times the employee’s regular rate.
Briana’s last pay stub shows a total “overtime” amount of $20,000 (which is her overtime premium paid at a rate of two times the individual’s regular rate of pay combined with the portion of the individual’s regular wages for the hours worked over 40 in a workweek).
Briana may use $5,000 as her 2025 qualified overtime compensation (the FLSA Overtime Premium amount, computed by dividing $20,000 by four).