Overtime and Tips Deductions

The IRS just provided some guidance on how the tips and overtime deductions will work. I wanted to spend a few minutes going over the details so that you can learn how it would be reported on your taxes and share this with friends and family.

Overtime

As a reminder, the OBBBA created Section 225, which allows you to deduct qualified overtime compensation.

This deduction is capped at $12,500 per return ($25,000 for joint filers) and is subject to a phaseout based on modified adjusted gross income. The phaseout begins when MAGI exceeds $150,000 for single filers and $300,000 for joint filers.

In order to qualify for the overtime deduction, it must, among other requirements, be paid to an individual who is both covered by and not exempt from the FLSA (also called an FLSA-eligible employee).

Note that some FLSA-ineligible employees can be eligible for overtime under state law or paid premium rates for certain work (e.g. 2x rate on the weekends). However, the compensation paid to FLSA-ineligible employees is not qualified compensation for the purposes of this deduction.

Here’s the tricky part: employers aren’t required to account for qualified overtime compensation in 2025. They aren’t required to provide this information in Box 14 of Form W-2. They could, but they don’t have to. They will for future years, though.

This means that you must make a reasonable effort to determine:

• Whether you are considered an FLSA-eligible employee (ask your HR/employer). If you aren’t, you can’t take the deduction.
• Figure out the amount you can actually deduct if your employer doesn’t populate Box 14 of Form W-2.

Let’s go over some examples:

1. You log into your payroll portal and it shows $5,000 for the entire year as the “FLSA Overtime Premium” (don’t confuse FLSA overtime premium with regular overtime; refer to example #2 for regular). You can use the entire $5,000 as the deduction.
2. You log into your payroll portal and it shows “Total Overtime” for the year of $15,000, which is the FLSA overtime premium combined with your regular wages. You can then divide the amount by 3, and $5,000 will be your deduction. This is because the regular wages (the 1x amount) aren’t part of the overtime deduction, and only the amount that exceeds your regular wage (the 0.5x amount) is counted for the purposes of overtime.
3. You log into your payroll portal and it shows “Total Overtime” for the year of $20,000, but you get paid 2x the rate and not the standard 1.5x. In this case, you can divide the amount by 4, and your overtime amount is $5,000.

Overall, I’m sure a lot of people will make mistakes trying to figure out the overtime amounts…

The big thing to understand is the the overtime compensation deduction is just the 0.5x portion of the 1.5x rate, not the full 1.5x rate (hence why you divide by 3 in example #2) 

Tips

Section 224 allows you to deduct qualified tips received during the taxable year and included on a statement furnished to you (a Form W-2) or reported using Form 4137.

The deduction is capped at $25,000 per year and is subject to an income-based phaseout. The $25,000 deduction phases out for taxpayers with MAGI over $150,000 ($300,000 for joint filers).

Modified adjusted gross income equals adjusted gross income (AGI) plus any amounts excluded under Sections 911, 931, or 933. For most people, MAGI equals AGI.

Section 224(d)(1) defines “qualified tips” as tips received by an individual in an occupation that customarily and regularly received tips on or before December 31, 2024. Sorry, CPAs.. you can’t get tipped $1,000 for that tax return you prepared. The Treasury provided a list of qualifying occupations (page 18 and onward).

Tips are also only qualified if they are received voluntarily, without any consequence in the event of nonpayment.

Here are some examples:

1. You are a server. Form W-2, Box 7, shows $20,000 of Social Security tips. You also didn’t report any additional cash tips on Form 4137. $20,000 can be used in determining the qualified tips for 2025.
2. You are a server. Form W-2, Box 7, shows $15,000 of Social Security tips. You also reported $4,000 of unreported tips on Form 4137. The total qualified tips are $19,000.
3. You are a self-employed travel guide who received $5,000 in tips from customers. You also received a Form 1099-K from an online booking platform showing $50,000 of payments. The Form 1099-K didn’t separately show the tips, but you keep a daily tip log showing the amount, date, and customer. You can use $5,000 in determining the qualified tips for 2025. Just keep the receipts and logs in this case.

For both the overtime and tips deductions, make sure you have proof of how you’ve determined the amounts eligible for these deductions. Keep your W-2, payroll statements, forms, etc. They may come in handy if the IRS starts asking questions.

For the 2026 tax year, filed in 2027, it should be much simpler, especially for the overtime deduction, as employers will be required to provide OBBBA amounts on Form W-2.

I hope you enjoyed this one, and feel free to respond back with any questions.