IRS Tip and Overtime Deduction Guide for Tax Changes 2025

The IRS has released guidance for handling the tip deduction and overtime deduction for the tax year 2025.

The IRS explains these rules in a news release about guidance for people who received tips or overtime in tax year 2025.

Employees who receive tips or overtime in 2025 can use this article as a guide. It explains how to calculate your deduction on your federal income tax return for the 2025 tax year.

This article summarizes that guidance in plain language so you can:

• Understand what counts as cash tips
• Choose an IRS-approved method to determine your tip deduction
• Apply the IRS methods to calculate overtime pay eligible for the overtime deduction
• Know what to do if your employer doesn’t provide all the statements you’d like
• Keep records that support your numbers if the IRS ever asks questions

For a broader overview of how these rules fit into the One Big Beautiful Bill, see our guide to tip income and the overtime pay deduction.

Note: This article is for general information only and does not replace advice from a qualified tax professional.

Who Should Read This Guide?

This guide is designed for employees who:

• Receive cash tips (including tips paid by credit or debit card), and/or
• Are paid overtime and want to understand how much of that overtime is eligible for the overtime tax deduction.

For the tip deduction, you must have received qualified tips in a job that the IRS lists as one that regularly received tips on or before December 31, 2024.

Many of the occupations on this IRS listinc are in restaurant, hospitality, and similar service industries.

This summary also helps employers, payroll teams, and tax professionals respond to employee questions about the 2025 rules.

According to IRS guidance, employees can rely on several sources to determine cash tips for the 2025 tip deduction.

This deduction is available only for “qualified tips.” For 2025, that means cash tips you received in a job that regularly received tips on or before December 31, 2024, as the IRS defines in its guidance.

Employees must be able to show that their job falls within one of those qualifying occupations. Recent IRS guidance on the No Tax on Tips provision under the One Big Beautiful Bill explains how these qualified tips work in practice.

Income limitations and phase-out rules

These deductions reduce your federal taxable income but they come with income limitations based on your modified adjusted gross income (MAGI). For 2025, the benefit begins to phase out for taxpayers when MAGI is above $150,000 for most single filers and above $300,000 for a married couple filing a joint return.

The IRS One Big Beautiful Bill fact sheet (FS-2025-03) provides more detail on how these MAGI-based income limits and phase-outs work for workers and seniors.

What Counts as Cash Tips?

You can treat tips paid in cash or by card as cash tips for this deduction when you follow IRS tip reporting requirements and report them on Form W-2, Form 1099, or directly as Form 4137 tips on Form 4137.

IRS-Approved Methods for Determining Cash Tips

According to the guidance, employees may use any of the following methods to determine the amount of cash tips for the tip deduction:

1. W-2 Social Security Tips (Box 7)

You may use the total amount of Social Security tips reported in Box 7 of your Form W-2.

2. Tips Reported on Form 4070

You may use the total amount of tips you reported to your employer on Form 4070 (Employee’s Report of Tips to Employer).

3. Tips Reported in Box 14 of the W-2 or on a Separate Statement

If your employer reports the amount of cash tips in Box 14 of your W-2, or on a separate written statement, you may use that amount.

4. Tips Reported on Form 4137

If you complete Form 4137 (Social Security and Medicare Tax on Unreported Tip Income) to report additional tip income, you may use the amount reported on that form.

Taxpayers may select any one of the four methods rather than using all of them. The IRS guidance lets you use any of these methods that fits the way your employer reports your tips and how you report them to the IRS.

Overtime Deduction: IRS Methods for 2025

These methods come directly from Notice 2025-69, which explains how workers should calculate qualified tips and qualified overtime compensation for the 2025 tax year.

The same IRS guidance also describes how individuals can determine overtime pay that is eligible for the overtime pay deduction.

Here, the key is finding the amount of qualified overtime compensation: the part of your pay that is the Fair Labor Standards Act overtime premium (the “half” in time-and-a-half), which the new no tax on overtime rules let you deduct from federal income tax on overtime.

IRS-Approved Methods for Determining Overtime Pay Eligible for the Deduction

Individuals may use any of the following methods to determine overtime pay eligible for the overtime deduction:

1. Method 1 – Employer Statement Showing the FLSA Overtime Premium

If you receive a statement from your employer showing the overtime premium paid during the tax year 2025, you can use that amount as the overtime pay eligible for the deduction.

2. Method 2 – One-Third of Combined Overtime Wages

If you receive a statement showing the total amount of overtime pay you received during the year (but not the premium separately), you may use one-third (1/3) of that amount as the overtime premium for the deduction.

3. Method 3 – Higher-Rate Overtime with Separate Premium

If you are paid overtime in excess of 1½ times your regular rate and receive a statement that separately accounts for the portion in excess of the regular rate, including situations where the overtime was paid at a 50% premium, you can multiply that amount by an appropriate fraction to approximate the FLSA overtime premium.

4. Method 4 – Higher-Rate Overtime with a Single Total (Method 4)

If you receive a statement showing total overtime pay, you may multiply that amount by an appropriate fraction to determine the FLSA overtime premium that is eligible for the deduction.

5. Method 5 – Adjusting the Fraction When It Is Too Low

If your employer provides a statement that clearly shows the FLSA 50% overtime premium for overtime paid at more than 1½ times your regular rate, you may use that stated premium amount as your qualified overtime compensation instead of estimating it with a fraction.

6. Method 6 – Using a Reasonable Method When No Statement Covers the Year (Method 6)

If you do not receive any of the statements described above covering the entire 2025 tax year, you may use a reasonable method to determine the proper deduction for your overtime pay.

The IRS guidance does not provide a detailed definition of “reasonable method.”

Taxpayers use a method that fits their pay records and keep pay stubs or employer statements as proof for the IRS.

How Employees Can Use These Rules in Practice

The IRS guidance focuses on approved methods, not on how you organize your records day to day. Here are some practical steps you can take, using those methods as the foundation. If you are working through year-end planning, you may also find our 2024 year-end tax planning guide helpful as you coordinate these new deductions with other strategies.

1. Gather Your Year-End Documents

For tips:

• Form W-2 (Box 7 and Box 14, if applicable), see the General Instructions for Forms W-2 and W-3 for details)
• Copies of Form 4070 you submitted to your employer
• Any employer statements summarizing your tips
• Form 4137, if you file it for unreported tips

For overtime:

• Year-end or periodic employer statements showing total overtime pay or overtime premium
• Pay stubs that distinguish regular and overtime pay where possible

2. Choose the Method That Matches Your Documentation

• If your employer supplies a clear overtime premium statement, method 1 may be simplest.
• If you only get total overtime pay, method 2 (1/3 of total) or method 4 (appropriate fraction) may apply.
• If your pay structure is more complex (for example, overtime above 1½× the regular rate), method 3 or an adjusted fraction under method 5 may be more appropriate.
• If you lack complete statements for the year, you may need to rely on a reasonable method under method 6.

3. Keep a Clear Paper Trail

Whatever method you use, you should:

• Keep copies of all statements and forms you relied on
• Note which method number (from the guidance) you used for tips and for overtime
• Retain any calculations in a simple spreadsheet or worksheet that can be shown to a preparer or the IRS if requested
• Keep your calculations in a simple spreadsheet or worksheet. Provide it to your tax preparer or to the IRS if they request it.

Frequently Asked Questions

The guidance you shared covers the 2025 tax year. It does not state that you must use the same method in other years.

For 2025, choose one IRS-approved method that matches the records you have. Use that same method consistently for the whole year.

Do I have to use the same method every year?

No. These special methods apply only for 2025. For your 2025 return, choose one IRS-approved method that matches the information you received and use it consistently.

For later years, you will follow the updated IRS instructions and new reporting requirements, which will have employers show qualified tips and qualified overtime directly on Forms W-2 and other statements instead of using these 2025 approximation methods.

For later years, you will follow updated IRS instructions and new reporting rules. Employers will list qualified tips and qualified overtime on Forms W-2 and other year-end statements. Because of that, you will no longer use these special 2025 approximation methods.

Can I mix different methods for tips and overtime?

Yes.

The IRS guidance treats tip deduction and overtime deduction separately. You can use:

• One of the tip methods (W-2 boxes, Form 4070, Form 4137, or employer statements) for tips, and
• One of the overtime methods (employer premium statement, one-third rule, appropriate fraction, reasonable method) for overtime pay.

Are tips paid by card treated like cash tips?

Yes.

The summary you provided specifically notes that cash tips include tips paid by credit or debit card.

You must report these tips properly using the usual forms and your employer’s standard procedures.

What if my employer doesn’t give me any overtime statements for 2025?

You may then use a reasonable method to figure out the correct deduction for your overtime pay. That reasonable method should be tied to:

• Your actual pay rates
• Your overtime hours
• The way your overtime is calculated under your employment agreement

Keeping detailed pay records is especially important if you rely on this option.

For a more technical discussion aimed at tax professionals, see KPMG’s TaxNewsFlash summary of Notice 2025-69.

When to Get Professional Help

Even with the IRS methods clearly laid out, determining your tip and overtime deductions can be complex if:

• You work multiple jobs
• Your overtime structure is unusual or changes during the year
• You do not receive clear or complete employer statements
• You are unsure how to document a “reasonable method”

A tax professional can help you:

• Select the most appropriate IRS method for your situation
• Confirm your calculations align with the 2025 guidance
• Prepare an audit-ready worksheet that ties your deduction amounts back to actual forms and pay statements

Conclusion: Using the IRS 2025 Guidance to Support Your Tip and Overtime Deductions

For the 2025 tax year, the IRS guidance gives employees:

• Four approved ways to figure out the amount of cash tips for this deduction. You can use amounts from your W-2, Form 4070, Form 4137, or employer statements.
• Several ways to figure out overtime pay that qualifies for this deduction. You can use the overtime premium shown on your pay statement from your employer. You can also use a fraction of your total overtime pay, such as one-third, or another reasonable fraction.

By understanding these methods and keeping solid documentation, you can:

• Report tip and overtime income more confidently
• Calculate deductible amounts in a way that aligns with IRS expectations and may lower your overall federal tax liability
• Be better prepared if questions arise about how you calculated your deduction

We can help you apply the IRS rules to your 2025 tips and overtime. Our individual tax services team will review your W-2s, employer records, and other forms. We will help you file a compliant, well-documented 2025 tax return and make the most of these new IRS tax deductions for 2025.