New Income Tax Deduction Guidance for Tips and Overtime Premium Pay

​The Treasury Department and the Internal Revenue Service (IRS) recently released new guidance for individual taxpayers who can claim the newly enacted federal income tax deductions for qualified tips or qualified overtime compensation for tax year 2025. 

Crucially, the guidance (Notice 2025-69) illustrates how workers can determine the deduction amount without receiving a separate accounting from their employer on tax return forms such as Form W-2, Wage and Tax Statement, or a Form 1099. The IRS published the guidance because the agency is not adding the tip and overtime premium pay deductions to the 2025 versions of employer-provided Form W-2; Form 1099-NEC, Nonemployee Compensation; Form 1099-MISC, Miscellaneous Information; or Form 1099-K, Payment Card and Third Party Network Transactions.

Employees may see new tax forms, as the IRS is updating individual income tax forms and instructions for taxpayers for tax year 2025 (such as a new Form 1040, Schedule 1-A, Additional Deductions).

No Tax on Tips
For the tip deduction, the IRS reiterates that pre-existing federal labor law already defines what a tip is and that only voluntary tips given at the sole discretion of the customer are eligible for the tax deduction. The Fair Labor Standards Act, or FLSA, clearly makes the distinction between a tip and a mandatory service charge added to a bill. The new tax law that established the individual income deduction for tips did not change anything related to the distinctions that FLSA makes between tips and mandatory service charges.

Additionally, the IRS says the law’s restriction on “specified service trade or business” (SSTBs) taking the deduction will not be in place for the 2025 or 2026 tax years. This could allow musical performers working in a restaurant or hotel to take the deduction before the SSTB restriction comes into effect.

No Tax on Overtime Premium Pay
The Treasury Department and the IRS acknowledged that employers manage different types of earnings statements and pay stubs, and employers provide overtime compensation in a variety of ways (such as combining State-required and FLSA-required overtime). For example, California law requires employers to pay premium pay when an employee works over 8 hours/day – this overtime would not be eligible for the deduction since the federal tax law relies on the FMLA standard definition for overtime premium pay.

• The IRS is now advising individuals to use the amounts reported as overtime compensation on earnings statements, pay stubs, and other documentation provided by payors to calculate the FLSA Overtime Premium for 2025.
• Individuals must maintain copies of any documents they rely on in accordance with IRS recordkeeping requirements.

How to Calculate Overtime Premium Pay Eligible for Deduction – Examples from the IRS

• Andrew works overtime during 2025, and he receives a payroll statement from his employer that shows $5,000 as the “overtime premium” that he was paid during 2025. Andrew may include $5,000 (the FLSA overtime premium) to determine the amount of qualified overtime compensation received in tax year 2025.

• Assume the same facts as in the first example except that Andrew’s payroll statement shows a total “overtime” amount of $15,000, which is the total amount Andrew was paid for working overtime (the FLSA overtime premium combined with the portion of his regular wages). Andrew may include the $5,000 FLSA overtime premium, computed by dividing $15,000 by 3 in determining the amount of qualified overtime compensation for 2025.
• Brad’s employer has a practice of paying overtime at a rate of two times an employee’s regular rate of pay, and Brad was paid $20,000 in overtime pay during 2025. Brad’s last pay stub for 2025 shows “overtime” of $20,000 paid in 2025. For purposes of determining the amount of qualified overtime compensation received in tax year 2025, Brad may include $5,000 ($20,000 divided by 4).

Learn more about how No Tax on Tips will make an impact on your workforce at a National Restaurant Association tax webinar on December 4.

*This update should not be considered tax, legal, or accounting advice and every restaurant operator and employee should work with their own tax professional before acting on these deductions, credits, or other tax decisions.*

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