Overview of the New Deductions
The OBBB (Public Law 119-21, enacted July 4, 2025) establishes two new tax deductions for individual taxpayers beginning in tax year 2025:
- Qualified tips: Employees or self-employed individuals in occupations that “customarily and regularly” receive tips (on or before December 31, 2024) may deduct up to $25,000 of qualified tips. However, this phases out for modified adjusted gross income (MAGI) over $150,000 (single) or $300,000 (married filing jointly). (irs.gov)
- Qualified overtime compensation: The portion of overtime pay (e.g. the "half" portion of time-and-a-half pay required by the Fair Labor Standards Act) may be deducted up to $12,500 individually ($25,000 joint filers), again with phase-out at the same MAGI thresholds. (irs.gov)
Employer and Payor Obligations + Transition Relief
Employers, payors, and lenders have new reporting obligations:
- They must file information returns and provide payee statements that show separate accounting of cash tips and the employee’s occupation; similarly for qualified overtime pay. Forms W-2 or 1099 may suffice if modified. (irs.gov)
- The IRS has provided penalty relief for tax year 2025: employers or payors won’t face penalties for failing to provide separate accounting of cash tips or overtime, or including occupation codes, if a correct and complete return or statement is filed otherwise. (irs.gov)
- The Forms W-2, existing Forms 1099, and payroll return forms will remain unchanged for tax year 2025. This simplifies compliance until new forms are released for 2026. (irs.gov)
Practical Examples
- Single employee named Sara, MAGI $160,000, works serving tables, earned $30,000 in qualified tips. Sara can claim up to $25,000, then phase out: over $150,000 by $10,000 ⇒ reduce her deduction by $1,000, yielding a qualified tips deduction of $24,000. Sara must include her SSN, file jointly if married, claim via return. (irs.gov)
- Couple filing jointly, MAGI $200,000, one spouse works overtime—qualifying overtime pay $20,000. They can deduct up to $25,000, but since their MAGI is over $150,000, phase-out applies: over by $50,000 ⇒ reduce the allowed deduction by $5,000, leaving $20,000 deduction. (irs.gov)
Key Takeaways for Employers & Individuals
- Employers/payors should begin collecting occupation information and separate accounting of tips and overtime even during 2025, though no penalties will apply during transition period for misreporting on those new items. (irs.gov)
- Individuals claiming the deductions must ensure they have accurate statements from employers/payors. If not yet available, keeping records or asking employer to use online portal/statements will help. (irs.gov)
- For withholding: employees may need to use the deductions worksheet on the 2025 Form W-4 rather than rely on the current Tax Withholding Estimator (which doesn’t yet include tips/overtime/certain deductions). (irs.gov)
Action Plan Checklist
- Identify whether your occupation is on the list of “customarily and regularly” tipped occupations (IRS will publish this; some guidance already available) (irs.gov)
- If you earn overtime/qualified tips and wish to claim the deduction, begin collecting required statements and ensure employer/payor cooperation for reporting.
- Employers to evaluate internal payroll systems and prepare to separate tip/overtime info correctly; consider Box 14 of W-2 or separate statements.
- Reassess withholding: update W-4 with deductions worksheet if applicable. Monitor IRS updates to withholding estimator for 2026.
Why It Matters
These changes provide more take-home pay potential, especially for service workers and those working significant overtime. They also introduce complexity & compliance risk, especially for businesses handling payroll, streamlining records, and for taxpayers to claim deductions effectively. Being proactive in 2025 will smooth transition into full enforcement in 2026.