Employers Need to Prepare Now for ‘No Tax on Tips’ Compliance

The administration’s tax-and-spending package enacts the widely publicized “no tax on tips” and “no tax on overtime” changes to the tax code. These provisions will decrease tax burdens for many employees while presenting new compliance obligations for employers.

These changes are retroactive to Jan. 1, 2025, so employers should be focused on these issues now. Coordination with payroll providers and clear messaging to employees will be imperative to respond to these changes.

The IRS has released FS-2025-03 with interim guidance on the changes, but more detailed guidance is expected in the coming months.

Here are the key things that employers should know.

No Tax on Tips

The new tax package allows a deduction of up to $25,000 for “qualified tips,” regardless of filing status for 2025 through 2028. A deductible qualified tip must be a voluntary tip received by an individual in an occupation designated by the US Treasury Department as one that “customarily and regularly” receives tips. This means employers can’t craft novel pay arrangements for traditionally non-tipped positions in response to the law.

The Treasury Department released a list of qualifying tipped occupations with its proposed regulations on Sept. 22. The proposed regulations list qualifying occupations in eight categories:

• Beverage and food service
• Entertainment and events
• Hospitality and guest services
• Home services
• Personal services
• Personal appearance and wellness
• Recreation and instruction
• Transportation and delivery

Merely having a job title on the Treasury Department’s list doesn’t guarantee that an employee qualifies for the deduction. This is because the department has stated that individuals in a specified service trade or business, known as SSTBs, aren’t eligible for the deduction.

Examples of SSTBs include businesses providing services in the fields of health, law, accounting, performing arts, athletics, or financial services. Additional guidance is necessary to determine exactly how the approved list of occupations interacts with the exclusion for SSTBs.

For example, “musicians and singers” is listed as an approved occupation, but a musician or singer is clearly in the field of performing arts, which is within the definition of SSTBs. The proposed regulations request comments by Oct. 22 about whether the definitions for SSTBs should be refined for purposes of the new deduction.

The tip also must be paid voluntarily without any consequence in the case of nonpayment, meaning that mandatory service charges or auto-gratuities aren’t considered qualified tips for purposes of the deduction.

No Tax on Overtime

Separately, the new tax package allows a deduction of up to $12,500 per individual ($25,000 if married) for certain overtime payments that an employee receives. The deduction is limited to “qualified overtime compensation” required to be paid under the Fair Labor Standards Act, which defines overtime as the number of hours worked in a week over 40 hours.

Other forms of premium pay aren’t subject to the deduction, such as where state law overtime requirements exceed those of the FLSA or a company policy or collective bargaining agreement provides for premium pay for certain shifts or certain types of work.

For example, if an employer’s policy provides for time and a half pay for work performed on a holiday or Saturday, that premium pay wouldn’t be considered qualified overtime compensation for tax deduction purposes unless the pay also qualifies as overtime required to be paid under the FLSA.

An additional administrative complication for employers is that only the compensation in excess of the regular rate can be included in the deduction. For example, if an employee’s regular rate of pay is $10 an hour, and they receive $15 an hour for overtime hours, only the $5 per hour overtime premium would qualify for the deduction.

Both the No Tax on Tips and No Tax on Overtime deductions begin to phase out for taxpayers earning more than $150,000 (or $300,000 if married).

New Employer Responsibilities

Because these changes are retroactive to Jan. 1, employers should be prepared to implement them for the full 2025 tax year. The IRS has stated that Forms W-2 and 1099-NEC won’t change to reflect new reporting requirements until tax year 2026.

The IRS has released draft 2026 tax forms so employers can get a sense of what W-2 forms will look like for tax year 2026, including new boxes for the total amount of qualified tips, the occupation code for tipped occupations, and total amount of overtime compensation.

For 2025, there is a transitional rule within the new tax law that allows employers to use a reasonable estimation method to determine the amount of qualified tips and qualified overtime by IRS-approved methods. The Treasury Department will issue additional guidance in the coming months as to how employers can calculate and report these amounts for 2025 under existing forms.

These new tracking and reporting requirements could prove more challenging to enact than might be expected, particularly for qualified overtime compensation. Many employer payroll systems currently report overtime compensation on a separate line item in an employee’s pay stub that includes the regular rate and the premium rate paid for the overtime hours.

However, as discussed above, only the premium rate (that is, the 0.5 of the 1.5 overtime paid) qualifies for the deduction and will need to be reported separately to claim the deduction.

Employers would be well-served to analyze the current tracking and reporting functionalities of their payroll systems now to ensure they are best positioned to comply with reporting requirements as new IRS guidance emerges in the coming months.

These new tax deductions offer meaningful tax relief for certain types of workers. Still, employers’ key role in successful implementation comes with new compliance obligations and reporting burdens. Early preparation and clear communication with employees and payroll providers will be critical.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Jason Feingertz is a tax partner with Hunton Andrews Kurth in New York.

Ryan A. Glasgow is a partner and Elizabeth King is an associate with Hunton Andrews Kurth in Richmond, Va.

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