By Philip Giorlando and Fred Preis
The IRS and U.S. Treasury issued new guidance on November 21, 2025, clarifying how employees and employers should handle the recently enacted federal income-tax deductions for qualified tips and qualified overtime compensation. The guidance also provides important transition relief for employers during the 2025 tax year.
Key Points for Employers
1. New Tax Deductions for Employees
Employees may deduct:
- Up to $25,000 in qualified tips, and
- Up to $12,500 in qualified overtime compensation (or $25,000 if married filing jointly)
from federal taxable income for tax year 2025.
These deductions phase out for higher-income employees and apply only to federal income tax. FICA taxes still apply to both tips and overtime. Additionally, state income taxes may still apply.
2. What Counts as Qualified Tips and Overtime
- Qualified tips include cash and credit-card tips that are voluntary and received in occupations that “customarily and regularly” receive tips (e.g., restaurant, hospitality, personal services, delivery positions).
- Qualified overtime compensation includes only the FLSA-required overtime premium—the additional half-time paid for hours worked over 40 in a week. Therefore, if an employee regularly earns $10 an hour and earns $15 an hour in overtime pay, only the additional $5 per hour is deducted. Other forms of extra pay generally do not qualify.
3. Transition Relief for Employers in 2025
The IRS will not impose penalties in 2025 for employers who do not separately report qualified tip and overtime amounts on Forms W-2 or other information returns. Updated forms and reporting fields will not be required until tax year 2026.
Although reporting is not required for 2025, the IRS “encourages” employers to provide employees with annual statements of tips and overtime to help them claim deductions on their returns.
BSW Labor and Employment Law Blog 