IRS Issues New Guidelines for Tax Deductions on Tips and Overtime

On November 21, 2025, the Internal Revenue Service (IRS) and the U.S. Department of the Treasury released crucial guidance on how workers can calculate their tax deductions for tips and overtime pay for the upcoming tax year. This guidance is particularly important for employees whose employers do not provide separate reporting on these earnings.

The IRS document outlines various scenarios to help individuals understand how to determine their tax deductions based on the payroll data they have access to. For example, the guidance covers situations involving a bartender with both reported and unreported tips, a self-employed travel guide receiving tips via digital payment apps, and a law enforcement employee compensated with overtime based on a fourteen-day work period.

Starting January 1, 2025, through December 31, 2028, workers who regularly receive tips can deduct up to $25,000 from their income subject to federal taxes. This deduction is applicable only to those earning less than $150,000 annually for single filers and $300,000 for joint filers. The IRS has identified eligible tipped occupations, which include bartenders, waitstaff, cooks, and various service industry professionals. Similarly, employees may deduct up to $12,500 or $25,000 in overtime pay, depending on their filing status, for the same period.

Reporting Requirements and Transition Relief

Employers play a critical role in enabling employees to claim these deductions. They are required to report qualified overtime compensation and tips on employees’ Forms W-2. However, the IRS has granted transition relief for the 2025 tax year, meaning employers will not face penalties for failing to report cash tips and overtime compensation as mandated by the latest federal budget reconciliation bill. Nevertheless, the IRS strongly encourages employers to provide this information to employees through various means, such as online portals or written statements.

For individual taxpayers, the IRS guidance details how to use available tax information to claim deductions for cash tips when no separate reporting statement is provided by their employer. For instance, a restaurant server whose 2025 Form W-2 indicates $18,000 in tips can deduct this full amount. In another example, a bartender reporting $20,000 in tips on Form 4070 and $4,000 in unreported tips can rely on either the amount from their W-2 or the total from Form 4070 to determine their deductible tips.

Calculating Overtime Compensation

The IRS also provides guidance on how employees can claim deductions for qualified overtime compensation when their employers do not furnish a separate report. Qualified overtime compensation, as defined under the Fair Labor Standards Act (FLSA), refers to pay for hours worked over forty in a week at a rate of no less than one and one-half times the regular pay rate.

Employees must first ascertain their eligibility under the FLSA, which may involve inquiring with their employers. They are then instructed to calculate qualified overtime compensation based on available documentation, such as pay statements and invoices. For example, if a year-end pay statement shows aggregate overtime compensation paid at a rate of one and one-half times for hours worked beyond forty hours, the employee can divide this total by three to determine the usable overtime amount for tax purposes.

In another scenario, a state government employee who earned $4,500 for compensatory time can include $1,500—one-third of this amount—in her tax deduction for overtime pay.

The IRS is currently updating Forms W-2, 1099-NEC, 1099-MISC, and 1099-K to reflect changes in the 2025 budget reconciliation bill. No alterations will appear on these forms for the 2025 tax year, but the IRS has urged employers to assist tipped employees by providing occupation codes and detailed accounting of cash tips. They are also encouraged to furnish employees with clear records of overtime pay to facilitate accurate claims for deductions.

With these new guidelines, employees now have the necessary instructions from the IRS to calculate their own qualified tips and overtime compensation, ensuring they can claim the appropriate deductions regardless of their employers’ reporting practices.