⏱ Estimated reading time: 8 min read
In late 2025, the IRS issued several important Notices providing guidance on how employees, gig workers, and employers should handle tips and overtime pay for the 2025 tax year. These deductions—created under the One Big, Beautiful Bill Act—will impact millions of U.S. workers.
Below is a clear breakdown of what the new deductions are, what IRS Notices 2025-62 and 2025-69 say, and how both employees and business owners can prepare.
A. Two New Above-the-Line Deductions Starting in 2025
The new deductions apply for tax years 2025 through 2028 and benefit both itemizers and non-itemizers. Both deductions require that the taxpayer have a valid Social Security Number and file MFJ (if married).
§224 – “No tax on tips”: Workers in tipped occupations may deduct up to $25,000 of qualified tips annually. Phaseout begins at $150,000 MAGI (single) and $300,000 (MFJ).
§225 – “No tax on overtime”: This deduction applies only to the overtime premium—the “half” in “time-and-a-half” required under the Fair Labor Standards Act (FLSA). Annual limit: $12,500 per taxpayer or $25,000 MFJ. Phaseout begins at $150,000 MAGI (single) and $300,000 (MFJ).
B. Notices 2025-62 & 2025-69
B.1 Notice 2025-62 – Information Reporting
Because payroll providers and employers will need time to update systems to track new data elements, the IRS is granting penalty relief under § 6721 for failure to file correct information returns and § 6722 for failure to furnish correct payee statements.
B.2 Notice 2025-69: Calculating Tips Deduction for 2025
In order to claim the deduction, a worker must both be in an occupation on the IRS’s list and receive qualified tips. On September 19th, 2025 the Department of the Treasury and the Internal Revenue Service provided guidance on “no tax on tips” provision. The proposed regulations list ~70 occupations of tipped workers, from bartenders to water taxi operators. To avoid too much wordiness below are the 8 categories in which the occupations are grouped in:
- 100s – Beverage and Food Service
- 200s – Entertainment & Events
- 300s – Hospitality & Guest Services
- 400s – Home Services
- 500s – Personal Services
- 600s – Personal Appearance & Wellness
- 700s – Recreation and Instruction
- 800s – Transportation & Delivery
Qualified tips include cash, card payments, checks, and tokens (exchangeable for a fixed dollar amount) as long as they are voluntary, non-negotiable, and from customers. Service charges (like a mandatory 18% added for large parties) are not qualified tips. In addition, payments received from illegal activities, prostitution, or pornographic services are not qualified tips.
To figure the deduction employees and non-employees can use the below listed items in determining their qualifying tips.
| Employees may use… | Non-employees (self-employed / contractors) may use… |
| 1. Form W-2, Box 7, Social security tips; 2. Form W-2, Box 14, Other (if employer includes cash tips here); 3. Total tips reported to employer (Form 4070 / internal tip reports); plus 4. Any additional tips reported on Form 4137, line 4 . | 1. Taxpayer may treat the separate statement requirement as satisfied if tips are included in the total on the 1099. Tips portion will be determined using (i)POS reports (ii) 3rd party settlement organization records (iii) daily tip logs and (iv)platform app / statements. |
Form 4070 Employee’s Report of Tips to Employer and Form 4137 Social Security and Medicare Tax on Unreported Tip Income are employee filed tax forms. Non-employees must keep documentary support to substantiate the calculation.
B3. Notice 2025-69: 2025 SSTB Exception for Tips
Section 224(d)(2) says qualified tips do not include any amount received if the tips are received in the course of a specified service trade or business (SSTB) as defined in §199A(d)(2).
Examples of SSTB’s include any trade or business involving the performance of services in field such as health, law, accounting, actuarial science, performance arts, consulting, financial services, brokerage services, investing & investment management, trading, dealing in securities, and any other 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 (e.g. NIL’s, endorsement deals, compensation for going on radio or talk shows).
For employees, the statute goes further stating that if the employer’s trade or business is an SSTB, then the employee is treated as receiving tips in a SSTB, and those tips are NOT qualified tips, even if the employee’s own role is non-professional (e.g. server in a law-firm cafe).
However, because this is the first time employees and employers have to make such a determination, the Treasury Department and the IRS believe that additional guidance is needed to assist employees and employers in determining whether an employer’s trade or business is a specified service trade or business (SSTB) and to implement such guidance.
Accordingly, Notice 2025-69 provides a transition period for purposes of IRS enforcement and administration with respect to the SSTB requirement. In specific, the Notice states:
“Until January 1 of the first calendar year following the issuance of final regulations on SSTB status for §224 and related reporting, the IRS will treat an employee as having received tips in a trade or business that is not an SSTB, as long as the employee is in an occupation that customarily and regularly received tips on or before December 31, 2024, as provided by the Secretary.“
This applies to both employees and non-employees.
B4. Notice 2025-69 – Calculating Overtime Deduction
“Qualified overtime compensation” is limited to overtime required under FLSA §7 (29 USC §207) and paid to a covered, non-exempt worker. If the worker is FLSA-ineligible but receives “overtime” under state law or employer policy, that is not qualified overtime for §225 purposes. For 2025 forms won’t break out the qualified overtime premium. As a result, the IRS is allowing for “reasonable methods” in determining the amount of over-time pay. A summary of the methods are listed below:
- Method A – Paid 1.5x regular wage -> Separately stated on W-2
- If paystubs show the FLSA overtime premium (the extra 0.5×), the employee may deduct that exact amount.
- Method B – Paid 1.5x regular wage -> NOT separately stated on W-2
- If pay statements show only a single “overtime” amount, the taxpayer may deduct 1/3 of that total.
- Method C – Paid > 1.5x regular wage -> Reported on W-2
- If overtime is paid at higher rates (e.g., 2×), and the “premium” portion is shown, the employee may multiply by an appropriate fraction (e.g., ½ for double-time).
- Method D – Paid > 1.5x regular wage -> NOT reported on W-2
- If only a combined double-time total is shown, the IRS allows the taxpayer to deduct ¼ of the total.
- Method E – If Methods B or D would underestimate qualified overtime, taxpayers can reasonably adjust upward.
- Method F -If no year-end summary is available, taxpayers can reconstruct the premium using:
- the regular rate paid to the individual by the employer and
- the individual’s hour of service in the excess of 40 hours in a workweek
A key theme in the Notice is preventing employers from relabeling bonuses or enhanced pay as “overtime” to inflate the deduction. This is addressed through Methods C & D where overtime exceeding “time & a half” isn’t considered.
C. How To Prepare for the new rules
Identify tipped workers:
1. In a tipped occupation before 12/31/2024?
2. Tips properly reported?
3. MAGI below $150k / $300k if MFJ
4. Must file MFJ if married.
Identify overtime workers:
1. Covered by FLSA?
2. Significant overtime in 2025?
3. Access to pay summaries showing overtime information?
4. Must file MFJ if married.
Update payroll & documentation practices:
1. Employers should provide clear year-end payroll summaries
2. Consider voluntary use of W-2 Box 14 (tips/overtime)
3. Workers should retain tip logs, POS records, paystubs, app statements
4. Ensure accurate SSNs for all taxpayers.
Plan around SSTB relief:
1. Tipped workers in SSTB can claim deduction in 2025 as long as employee / non-employee is in an occupation that customarily and regularly received tips prior to 12/31/2024.
2. Workers should be flagged for proper reporting in the future.
D. Final Thoughts
The new “no tax on tips” and “no tax on overtime” rules represent some of the most significant wage-related deductions in recent years. With roughly 6 million Americans receiving tips and tens of millions working overtime, these deductions have the potential to change refund outcomes for a huge portion of taxpayers. If you have any questions regarding the new proposed regulations, shoot us an email.
Disclaimer: The information provided herein is intended solely for informational purposes and no person(s) or other third-party may rely upon it as financial, tax, or legal advice or use it for any other purposes. As a result, Royal Financial, and any affiliates, assume no responsibility whatsoever to readers, or any other persons for that matter, as a result of the information contained herein.