Qualified tips and qualified overtime tax deductions: What employees need to know

General FAQs

A new U.S. federal law called the One Big Beautiful Bill Act (the Act) created two new individual income tax deductions: a deduction for qualified tips and a deduction for qualified overtime pay.

These changes apply retroactively to Jan. 1, 2025, and the IRS has issued guidance to help people claim the deductions accurately when filing their 2025 tax return.  

Not quite. These are federal income tax deductions. The deductions are claimed on individual year-end tax returns and can reduce the amount of income that’s subject to federal income tax, up to certain limits. 

The limit is up to $25,000 for qualified tips. The limit for qualified overtime is $12,500 or up to $25,000 if you are married and filing jointly.

These deductions phase out on a sliding scale if you are a higher-income earner. Details about this can be found on the IRS website. 

Individuals may want to consult a tax advisor for guidance on how to calculate their specific deductions and prepare their tax return.

Qualified tips

"Qualified tips" means cash tips voluntarily provided to an individual in an occupation which customarily and regularly received tips on or before Dec. 31, 2024. "Cash tips," for purposes of the Act, include tips received from customers that are paid in cash or charged and, in the case of an employee, tips received under any tip-sharing arrangement. 

Yes. For 2025, the deduction is capped at $25,000, and it can phase out if your income is higher. Details about this can be found on the IRS website. 

If you received a Form W-2 (Wage and Tax Statement) that includes tip information, you can use the information in W-2 Box 7 for 2025. 

You can also use tips you reported to your employer during the year, such as a Form 4070 or similar form, or tip information that your employer voluntarily provided to you.

If you are an independent contractor, you can use documentation such as receipts and daily logs.

For 2025, it is your responsibility to confirm that your tips were earned in a qualifying occupation. Starting in 2026, employers will be required to include a new tipped occupation code on Form W-2 and certain Forms 1099. 

Qualified overtime

For 2025, the IRS guidance focuses on overtime as defined within the Fair Labor Standards Act (FLSA), which means that the guidance generally applies to employees who are nonexempt under the FLSA. Typically, nonexempt employees are hourly employees eligible for overtime under federal law. 

If you are FLSA-exempt, you typically will not qualify for the overtime deduction. Salaried roles are often FLSA-exempt. 

The FLSA generally defines qualified overtime as hours worked in excess of 40 hours in a week that are paid at a rate of 1.5 times the employee’s regular rate of pay. Overtime not required by the FLSA (such as potentially more generous overtime required under state laws, a collective bargaining agreement or paid voluntarily by employers) is therefore not eligible for the deduction.

Yes. For 2025, the deduction is capped at $12,500 for an individual filer or $25,000 for those married filing jointly, and it can phase out if your income is higher. Details about this can be found on the IRS website. 

Because this is the first year that the Act is in effect, the reporting process is not yet fully uniform and standardized. Employees are expected to use a “reasonable method,” as identified by the IRS, to determine whether they are FLSA nonexempt and to estimate their overtime amount. ADP recently published a blog post on this topic, which can help you better understand what amount may qualify and how to calculate the deductible amount.

The IRS suggests multiple methods for calculating your overtime. Generally:

• If you have documentation that clearly shows the overtime premium portion above your regular pay rate, use the amount shown.
• If your documentation shows total overtime pay but does not list the overtime premium portion separately, you may use 1/3 of the total overtime compensation as your qualified overtime amount.
• If you worked for more than one employer in 2025, it may be necessary to use different accounting methods depending on the available documentation.

Please consult a tax professional if you have any questions regarding this information.

Yes. As with any tax deduction, if you claim the qualified tips and/or overtime deduction, you should keep copies of all documentation in your files. 

No. Tax filers must claim the deductions when filing their tax return. 

Yes. 2025 is considered a transition year as these new rules are rolled out. Taxpayers are advised to expect additional guidance from the IRS for tax years 2026-2028.

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