What’s New in Tip & Overtime Deductions
- For the 2025-2028 tax years, taxpayers who receive “qualified tips” may deduct up to $25,000 ($150,000 MAGI threshold for phaseout, $300,000 for joint filers). (irs.gov)
- Similarly, qualified overtime compensation (the portion of overtime pay required by FLSA above the regular rate) may be deducted up to $12,500 ($25,000 if married filing jointly). (irs.gov)
- These deductions are available regardless of whether you itemize or use the standard deduction. (irs.gov)
- Employers are required to separately report these amounts starting in tax year 2026, but 2025 has transition relief—employees can use employer statements, pay stubs, or logs. (irs.gov)
Backup Withholding & Reporting Threshold Changes
- Proposed regulations were issued (IR-2026-03) to revise thresholds for when third-party settlement organizations (TPSOs) must perform backup withholding on payments made through platforms. (irs.gov)
- Under the new proposed threshold, backup withholding applies only when both the total payments exceed $20,000 and the number of transactions exceeds 200. This replaces earlier lower thresholds. (irs.gov)
- The regulations also reflect changes made by OBBB that restored the pre-American Rescue Plan Act of 2021 thresholds for Form 1099-K reporting. (irs.gov)
Practical Compliance Steps for Tax Professionals & Businesses
- Update payroll systems to accommodate separate reporting of overtime and tip deductions starting 2026. For tax year 2025, ensure you have proper documentation: pay stub entries or statements that clearly identify qualified overtime or tips. (irs.gov)
- Educate employees/site workers about the new deductions—they may need to keep logs or be able to estimate their unreported tips. (irs.gov)
- TPSOs and platforms should track number of transactions and gross payments per payee—ensure internal reporting systems align with thresholds of $20,000 + 200 transactions. (irs.gov)
- Retain documentation—if audited, IRS guidance requires records such as pay stubs, statements, logs showing the required amounts for tips/overtime. (irs.gov)
Example Scenarios for Compliance
- Platform Seller: Sara sells crafts on an online marketplace. She receives 180 transactions totaling $25,000. Under proposed rules, since number of transactions <200, backup withholding should not apply.
- Gig Worker with Tips: Carl bartends and has Form W-2 box 7 showing $10,000, plus unreported cash tips. He may gather his tip log and Form 4137 to claim up to $25,000 in qualified tip deduction if MAGI allows.
- Overtime Worker: Mike works 50 hours weekly; his employer pays 1.5× regular rate. The FLSA overtime premium portion (e.g., the “half-time” above regular pay) is the part eligible for deduction. For 2025, he should capture payroll statements; starting 2026, employers will report separately. (irs.gov)
Key Takeaways
- These are permanent compliance changes—plan your systems and recordkeeping now.
- For 2025, benefit from transition relief, but documentation is crucial.
- TPSOs need to understand new reporting thresholds to avoid over-withholding or errors.
- Watch/comment on proposed regulations before finalization—comment periods give opportunity for input.
Aligning with these changes early can help minimize headaches and maximize deductions for both individuals and businesses.