The One Big Beautiful Bill Act (OBBB), signed into law on July 4, 2025, created two new above-the-line deductions that workers can claim on their personal tax returns beginning with tax year 2025: a deduction for qualified tips and a deduction for qualified overtime compensation.
These deductions are claimed by workers when filing their personal tax returns. For 2025, they do not change how companies calculate or issue payroll, but they do introduce new information-reporting expectations that companies should understand to support their workforce. The IRS has also announced penalty relief for tax year 2025, making this a transition year for compliance.
This guide provides a clear overview of what companies should understand about these new provisions.
Workers performing work in occupations that customarily and regularly received tips on or before December 31, 2024—such as restaurant servers, bartenders, and Front-of-House staff—may qualify for this deduction. The IRS guidance refers taxpayers to its proposed regulation identifying 68 such occupations.
Only tips that are voluntarily given by customers qualify. This includes cash tips that workers report, as well as tips added electronically or via credit card. Tips reported on Form 4070 or included on Form 4137 also count as qualified tips.
Automatic gratuities, such as mandatory service charges for large parties, or any other mandatory service fees that the customer did not voluntarily choose, are treated as wages rather than tips and cannot be deducted under this new rule.
For tax year 2025, the IRS will not update Form W-2 to include separate reporting for qualified tips. As a result, workers will need to rely on alternative sources to determine their deductible tip amounts. Alternative sources include:
Companies are highly encouraged to give workers a breakout of cash tips and occupation information for 2025. Doing so not only helps workers accurately claim the deduction but also prepares companies for the new W-2 reporting fields (codes TP, TT, and the new occupation code) that are expected in 2026.
The second deduction applies only to qualified overtime compensation, which is limited to overtime required under the Federal Fair Labor Standards Act (FLSA).
Only the overtime premium portion, the half in “time-and-a-half” compensation amount, qualifies as deductible overtime under FLSA.
Any overtime beyond what FLSA requires, including:
Because of this distinction, companies operating in states with daily overtime rules—most notably California—will need to ensure workers can distinguish between FLSA-qualified overtime and other forms of overtime compensation when claiming their deduction.
If companies do not provide workers with a specific breakout for eligible overtime worked, workers must use a reasonable method to determine the amount, typically:
One-half of their FLSA regular rate × Hours worked over 40 in the workweek
If a company pays at the standards FLSA “time and a half” rate and provides workers with total pay they earned, workers may generally use one-third of that number to calculate the half-time premium amount that is eligible for deduction. Higher multipliers (e.g., double time) require proportional adjustments.
Under the OBBB, companies will eventually be required to report total cash tips, the worker’s qualifying occupation, and the amount of qualified overtime compensation on the Form W-2 beginning 2026.
2025 is a transition year
Because Forms W-2 and 1099 will not be updated until 2026, the IRS has issued Notice 2025-62, providing penalty relief for 2025.
This means:
Best practices for 2025
Even though separate reporting is not required for tax year 2025, it is still strongly recommended that companies make every effort to provide their workers with clear, accurate information. The IRS encourages companies to provide:
Providing this information not only helps workers correctly claim the new deductions on their personal tax returns but also supports transparency and good practices. Additionally, offering a clear breakout of these amounts in 2025 allows companies to prepare for the transition to 2026, when new W-2 codes and reporting requirements will become mandatory and the IRS’s penalty relief will no longer apply.
It’s important for companies and workers to understand what stays the same:
Workers must determine whether they qualify
This includes verifying occupation eligibility, income thresholds, and correct amounts.
Beginning with tax year 2026, the IRS will implement formal reporting requirements for both the new tip and overtime deductions. The agency has already released an early draft of the 2026 Form W-2, which introduces several new fields tied to the One Big Beautiful Bill Act. Under the draft instructions, companies will report a worker’s qualified tips in Box 12 using the new code TP and will report qualified overtime compensation using code TT. The form is also expected to include a newly created Box 14b, where companies must list the worker’s qualifying occupation using the appropriate tipped occupation code.
Because the IRS has emphasized that this version of the W-2 is an early release, additional adjustments are possible before the form is finalized. With these changes on the horizon and penalty relief ending after 2025, companies should use the transition year to put tracking processes in place to ensure full compliance starting in 2026.
The “No Tax on Tips” and “No Tax on Overtime” deductions represent significant changes to how workers can reduce their taxable income and they come with nuanced definitions companies should ensure they understand.
With 2025 treated as a transition year and penalty relief in place, now is the ideal time for companies to familiarize themselves with which tips qualify, how FLSA overtime differs from state-mandated overtime, and what information workers will rely on when filing their tax returns.
That’s where TCWGlobal steps in to help. As a full-service Employer of Record, TCWGlobal helps companies navigate these complex deductions while ensuring compliance across multiple states. From accurate payrolling and reporting to helping workers access new tax benefits, our services take the administrative burden off your team. By leveraging our expert support, your company can confidently manage the 2025 transition and prepare for the full reporting requirements that begin in 2026.
Let TCWGlobal help you stay compliant while focusing on what you do best: growing your team, not decoding complex labor law updates.