Since the enactment of the “One Big Beautiful Bill Act” (OBBBA) on July 4, 2025, employers have awaited guidance on recordkeeping and reporting obligations related to the law’s “no tax on tips” and “no tax on overtime” deductions. The IRS has now announced that, for the 2025 tax year, employers will not be penalized for not separately reporting tips or overtime pay on tax forms, giving organizations time to adjust to these significant changes. While this transition relief eases immediate compliance concerns, new reporting requirements will take effect in 2026, and employers should use this period to review payroll systems and recordkeeping practices. Employers are also encouraged to help employees claim available deductions by providing information about their tips and overtime, and should stay alert for further IRS guidance as implementation continues.
Recap of the Tip and Overtime Deductions
The “no tax” term is a bit misleading. Both the “no tax on tips” and “no tax on overtime” provisions actually create limited income tax deductions for qualifying individuals, rather than making tips or overtime entirely tax-free. Importantly, these deductions do not affect the taxability of tips or overtime pay for Social Security and Medicare (FICA) taxes.
As discussed in our earlier blog post here, the OBBBA introduced two new deductions for individuals, which also raise several compliance questions for employers:
- No Tax on Tips: Employees (and self-employed individuals) in occupations that “customarily and regularly” receive tips may claim an above-the-line deduction for up to $25,000 in “qualified tips” from their taxable income.
- No Tax on Overtime: Workers may deduct up to $12,500 in “qualified overtime compensation” from their income subject to federal income tax ($25,000 for joint filers).
The OBBBA left several questions unanswered, including (1) how should employers account for and report a worker’s qualified tip amount; (2) which occupations qualify for the tip deduction; and (3) how should employers account for and report qualified overtime compensation? The IRS is working to address these uncertainties, which, if left unaddressed, have the potential to frustrate employers preparing for the 2026 tax season. Notably, the OBBBA allows employers to “approximate” the amount of “qualified overtime compensation” using a “reasonable method,” but further IRS guidance is still pending on what constitutes a “reasonable method.”
Transition Relief for Tax Year 2025
On November 5, 2025, the IRS issued Notice 2025-62, providing penalty relief to employers for tax year 2025 relating to the new reporting requirements for qualified tips and qualified overtime compensation under the OBBBA. This means employers will not be penalized for failing to separately report qualified tips or the occupation of the workers receiving such tips, or for failing to report the total amount of qualified overtime compensation. In its news release, the IRS acknowledged that “employers and other payors may not currently have the information required to be reported under the [OBBBA], or the systems or procedures in place to be able to correctly file the additional information with the IRS, or SSA in the case of a Form W-2, and provide it to employees and other payees.”
The IRS encourages employers to provide employees, particularly those in tipped occupations, with their occupation codes and a separate accounting of cash tips, so employees can claim the deduction for qualified tips for tax year 2025. The IRS likewise encourages employers to provide employees with separate accountings of overtime compensation, so that they can claim the deduction for qualified overtime compensation for tax year 2025. Employers can make the information available to employees through an online portal, written statements, or (in the case of qualified overtime compensation) in box 14 of Form W-2.
Qualifying Occupations and Qualified Tips
To qualify for the “qualified tip” deduction under the OBBBA, a worker must be in an occupation that “customarily and regularly” receives tips and must receive qualified tips. On September 19, 2025, the IRS issued proposed regulations identifying nearly 70 occupations that qualify, grouped into eight categories: (1) beverage and food service; (2) entertainment and events; (3) hospitality and guest services; (4) home services; (5) personal services; (6) personal appearance and wellness; (7) recreation and instruction; and (8) transportation and delivery.
The IRS explained that the proposed list was drafted “based on a review of IRS data, legislative history, and survey data regarding tipped occupations and the presence of certain factors demonstrating that those occupations customarily and regularly received tips.” Notably, certain occupations, such as dishwashers, are included even though they do not typically interact with customers for purposes of the Fair Labor Standards Act (FLSA). The IRS explained that “certain occupations that may not involve direct interactions with customers should still be considered occupations that customarily and regularly received tips if employees in such occupations participated in tip-sharing arrangements such as tip pooling or tip-outs with employees who do interact with customers.” Employers should review the preliminary list to determine whether they have employees who meet the proposed definition of “occupations that customarily and regularly received tips.”
Other important limitations on the qualified tips provision include:
- Voluntary Tips Only: “Qualified tips” must be paid voluntarily by the customer and not subject to negotiation. This means that qualified tips do not include automatic service charges (i.e., an automatic added service charge for large parties if there is no option for the customer to disregard or modify it).
- Illegal Activity Exclusion: Any amount received for illegal activity, prostitution services, or pornographic activity is not a qualified tip.
- Income Phase-Out: The deduction phases out for taxpayers with modified adjusted gross income over $150,000 ($300,000 for joint filers).
- Certain Service Business Excluded: Certain specified service trade or business activity is excluded from this provision. Those trades or businesses include: (a) performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners, or (b) those involving the performance of services that consist of investing and investment management, trading, or dealing in securities, partnership interests, or commodities.
Changes to Form W-2
On August 5, 2025, the IRS issued a news release announcing that Forms W-2 and 1099 for tax year 2025 would not be updated to account for the changes implemented by the OBBBA. Thus, employers are to use the current Forms W-2 and 1099 for tax year 2025, which do not have separate boxes for reporting qualified tips or qualified overtime compensation. Employers should prepare to comply with updated reporting requirements for tax year 2026 and ensure adequate systems are in place to track this type of compensation starting on January 1.
In fact, the IRS has already released a draft Form W-2 for tax year 2026, which is intended to address the new reporting requirements under the OBBBA for tipped and overtime workers. The draft Form W-2 includes a new Box 14b for employers to report the employee’s qualifying occupation (a “Treasury tipped occupation code”). The draft instructions direct employers to use Box 12 to report the employee’s “qualified tips” using code “TP” and “qualified overtime compensation” using code “TT.” The draft form is for informational purposes only and should not be used for tax year 2025, but it provides insight into future reporting requirements and can help employers plan system changes.
Takeaways
The IRS is expected to continue releasing guidance on the OBBBA requirements. In the meantime, employers should continue to maintain accurate records and plan ahead for new tracking and reporting requirements. While employers can avail themselves of the penalty relief in Notice 2025-62 for not reporting qualified tips or qualified overtime compensation on the relevant Forms W-2 and/or 1099 for tax year 2025 (as long as the forms are otherwise accurate, complete, and timely), employers should still make this information available to employees. Because not all tips or overtime may qualify, employers should review existing tip and overtime policies in light of the OBBBA and recent IRS guidance to determine applicability.