IRS offers penalty relief for reporting tips and overtime pay

The Internal Revenue Service and the Treasury Department issued guidance Wednesday giving penalty relief to employers and other payors for tax year 2025 on the new information reporting requirements for cash tips and qualified overtime compensation under the One Big Beautiful Bill Act that Congress passed in July.

The OBBBA added sections 224 and 225 to the Tax Code, temporarily allowing a deduction for individual taxpayers for qualified tips and overtime compensation through 2028. To claim the deductions, separate reporting of qualified tips and qualified overtime compensation needs to be entered on information returns, including Form W-2 and Form 1099-NEC, Nonemployee Compensation. The new law amended the applicable Chapter 61 rules to require information reporting of qualified overtime compensation and qualified tips by employers and businesses to align with the requirement in sections 224 and 225 that qualified tips and qualified overtime compensation be included on information returns.

Notice 2025-62 includes information on the penalty relief from the new information reporting requirements for cash tips and qualified overtime compensation under the OBBBA to employers and other payors for not filing correct information returns and not providing correct payee statements to employees and other payees. The notice provides relief from the penalty under Section 6721 of the Tax Code for failure to file correct information returns and the penalty under Section 6722 for failure to furnish correct payee statements. The penalty relief applies only for tax year 2025. 

Employers and other payors won't face penalties for failing to provide a separate accounting of any amounts reasonably designated as cash tips or the occupation of the person receiving such tips. In addition, employers and other payors will also not face penalties for failing to separately provide the total amount of qualified overtime compensation. The relief is limited to returns and statements filed and provided for tax year 2025 and applies only to the extent that the person required to make the return or statement otherwise files and provides a complete and correct return or statement. 

The Treasury and the IRS said they're aware that employers and other payors may not currently have the information required to be reported under the OBBBA, or the systems or procedures in place to be able to correctly file the additional information with the IRS, or the Social Security Administration in the case of a Form W-2 and provide it to employees and other payees. Moreover, the IRS previously announced back in August that Forms W-2 and 1099 for tax year 2025 won't be updated to account for the OBBBA-related changes. That means tax year 2025 will be treated as a transition period for IRS enforcement and administration of the new information reporting requirements for cash tips and qualified overtime compensation under the OBBBA.

While it's not a requirement to receive the penalty relief provided in Notice 2025-62, the IRS and the Treasury are encouraging employers and other payors to provide to employees and payees, especially those in a tipped occupation, with the occupation codes and separate accountings of cash tips, so the employee or payee can claim the deduction for qualified tips for tax year 2025. Similarly, they're encouraging employers and payors to provide employees and payees with separate accountings of overtime compensation, so the employee or payee has readily available the information necessary to claim the deduction for qualified overtime compensation for tax year 2025. Employers and payors can make the information available to their employees and payees through an online portal, additional written statements provided to the employees or payees, other secure methods, or in the case of qualified overtime compensation in Box 14 of the employee's Form W-2.

No tax on tips: Certain employees and self-employed individuals who receive qualified tips may deduct qualified tips that are reported on a Form W-2, Form 1099, or reported directly by the individual on Form 4137. Employers and other payors must file information returns with the IRS, or SSA in the case of Form W-2, and provide statements to taxpayers showing certain cash tips received during the year and the occupation of the tip recipient.

"Qualified tips" are voluntary cash or charged tips received from customers or through tip sharing. The maximum annual deduction is $25,000. For self-employed people, the deduction can't exceed the individual's net income (without regard to this deduction) from the trade or business in which the tips were earned. The deduction phases out for taxpayers with modified adjusted gross income over $150,000 ($300,000 for joint filers)

No tax on overtime: Certain individuals who receive qualified overtime compensation may deduct the qualified overtime compensation that is reported on a Form W-2 or Form 1099. Employers and other payors are required to file information returns with the IRS, or SSA in the case of Form W-2, and provide statements to taxpayers showing the total amount of qualified overtime compensation paid during the year. Effective for 2025 through 2028, individuals who receive qualified overtime compensation can deduct the pay that exceeds their regular rate of pay (such as the "half" portion of "time-and-a-half" compensation) that is required by the Fair Labor Standards Act and reported on a Form W-2, Form 1099, or other specified statement furnished to the individual. The maximum annual deduction is $12,500 (or $25,000 for joint filers). The deduction phases out for taxpayers with modified adjusted gross income over $150,000 (or $300,000 for joint filers). The deduction is available for both itemizing and non-itemizing taxpayers.

More guidance for individual taxpayers addressing how they can claim the deductions for qualified tips and qualified overtime compensation when they file their tax year 2025 returns is planned in the future.