Washington News

On November 5, the Internal Revenue Service (IRS) and the Department of Treasury published guidance providing penalty relief to employers and taxpayers for tax year 2025. The One Big Beautiful Bill Act (OBBBA) passed a new deduction for tips and qualified overtime compensation.

The “No Tax on Tips” deduction is allowed for up to $25,000 in tips in years 2025 through 2028. The deduction is phased out for single individuals with income over $150,000 and joint filers who earn over $300,000. A taxpayer will lose $100 of exclusion for each $1,000 over the excess amount.

The qualified overtime exclusion is allowed for up to $12,500 ($25,000 for joint filers), in years 2025 through 2028. The overtime exclusion applies to taxpayers with modified adjusted gross income of up to $150,000 ($300,000 for a joint return). There is a 10% phaseout above those levels. The overtime benefit phases out for single taxpayers with income of $275,000 and joint taxpayers with joint income of over $425,000. The overtime pay must be in excess of the normal full-time pay rate. If an employee earns $18 per hour and is paid $27 per hour for overtime, only the $9 per hour for overtime pay is deductible.

With the new deductions, employers and other payors are required to file information returns to the IRS or Social Security Administration (SSA) and provide statements to taxpayers with the total amount of qualified overtime or cash tips received during the year.

IRS Notice 2025-62 provides penalty relief for employers related to the filing of information reporting requirements in tax year 2025. Employers will not have penalties for failing to provide a separate accounting of the cash tips or qualified overtime compensation to employees. The penalty relief is an acknowledgement that employers may not have the information required to be able to file accurate information returns to the IRS or SSA or the information statement to the employee. The 2025 tax year will be a transition period for enforcement and administration of these new deductions.

Editor's Note: Additional taxpayer-centric guidance related to the two new deductions will need to be provided before the 2025 tax filing season. It will be challenging for employers to comply with the new information returns, educate employees and ensure compliance with a complex law.