The law commonly referred to as the One, Big, Beautiful Bill Act, or OBBBA, offers two new temporary deductions for individuals with qualified tips and qualified overtime compensation. Both deductions are available for tax years 2025 through 2028.

A qualified tips deduction is worth up to $25,000 per return and phases out once modified adjusted gross income exceeds $150,000, or $300,000 for married couples filing jointly. The qualified overtime compensation deduction is worth up to $12,500 per individual, or $25,000 for those filing jointly, with the same phaseout thresholds.

Under OBBBA, taxpayers are expected to look for qualified tips and overtime amounts reported on Forms W-2 and 1099 before applying AGI and other limitations. However, earlier this year the IRS stated there would be no update to those forms for 2025, and therefore there would be nowhere to report information on the new deductions. Forms for 2026 are being updated and should be ready to report as required by the OBBBA.

Next the IRS provided formal penalty relief for 2025 reporting, encouraging employers to provide this information in statements and the like, but not mandating it. This latest guidance provides relief for individuals and examples of how to support a deduction for 2025 absent W-2 and 1099 information.

 

An additional restriction applies to the tips deduction. OBBBA provides that no deduction is allowed if the business is considered an SSTB, and this limitation applies to employees of an SSTB as well. Proposed regulations on qualified tips provided a list of eligible occupations for the tips deduction but also clarified that SSTBs on that list would be ineligible. 

As this SSTB distinction is bound to cause confusion, Notice 2025-69 suspends the SSTB restriction until January 1 of the first calendar year following the issuance of applicable final regulations.

Long story short – we don’t need to worry about the SSTB restriction for a qualified tips deduction for 2025.
 

Some workers may be surprised to learn that while they received overtime compensation, they are ineligible for the new deduction.

IRS guidance explains that the deduction is only available to employees covered by specific Fair Labor Standards Act (FLSA) overtime rules. Employees who are exempt from the FLSA overtime requirements cannot claim the deduction, even if state law or union agreements mandate overtime pay. Furthermore, the guidance states that individuals must make a reasonable effort to determine if they are FLSA-eligible, which could include asking employers about their status.

Additionally, the deduction applies only to hours worked over 40 in a workweek, as defined by the FLSA. State laws requiring daily overtime or other variations do not override the federal standard for a deduction.

Another quirk is that the IRS has narrowly defined eligible overtime as only the “half” portion of time-and-a-half pay required under FLSA. For example, if an employee earns $20/hour and is paid $30/hour for overtime, the deductible portion is $10/hour. Payments above FLSA time-and-a-half requirement, such as double time, do not qualify.

Special rules apply for certain employees, such as those in the public sector, hospitals, and residential care facilities.

 

For 2025, the IRS has provided alternative substantiation methods as explained below.

Tips

For employees, the following options are listed to support a qualified tips deduction:

1. Amounts reported on Form W-2, box 7 social security tips, 
2. Amounts reported by an employee to an employer on Forms 4070, or similar reporting, or
3. Amounts voluntarily included on Form W-2, box 14.
4. In addition to options 1-3, employees may also include any amount listed on Form 4137, line 4, if that amount is included on the employee's income tax return as taxable income.

An earnings statement or tip log can be used by independent contractors.

Individuals seeking a qualified tip deduction are responsible for determining whether the tips were received by one of the IRS list of eligible occupations, since this information is not required to be provided by payors for 2025.

Overtime

The following substantiation options are listed for a qualified overtime compensation deduction:

1. Amounts voluntarily included by an employer on Form W-2, box 14
2. Amounts voluntarily provided by an employer in a statement
3. Pay statements, invoices, or similar statements

If amounts listed include just the “half” portion of overtime pay, the amount can be used without an adjustment. However, if the amounts include total overtime compensation (e.g., both premium pay and regular pay), an adjustment is needed. If the overtime rate of pay is time and half, use 1/3 of reported overtime compensation; if it is double time, use 1/4 of reported overtime compensation.

Despite IRS efforts to ease into the new OBBBA deductions, this coming tax season may still be challenging. Employers may be asked questions by employees. And tax professionals may be the middleman between taxpayers and their employers.

Employees could consider getting a head start by confirming FLSA eligibility, reviewing eligible occupations for the tips deduction, and gathering overtime pay or tips records. Employers might consider providing voluntary statements or optional Form W-2 reporting to assist employees. Anticipating questions now may save headaches down the road.