Tips and Overtime Deductions for 2025 and 2026Transition Relief, Reporting Gaps, and Open Compliance Issues

Tips and Overtime Deductions for 2025 and 2026Transition Relief, Reporting Gaps, and Open Compliance Issues

The tips deduction is available only when tips are received in a non-specified service trade or business (non-SSTB) and claimed on Schedule 1-A. The IRS has provided transition relief on this issue by stating that no business will be treated as a specified service trade or business until January 1 of the year following the year in which the IRS issues formal guidance.

If the IRS issues SSTB guidance for the tips deduction in 2026, then for tax years 2025 and 2026, all businesses may be treated as non-SSTBs for purposes of the deduction. This relief does not eliminate the requirement that tips be received in a business that ordinarily and customarily received tips on or before December 31, 2024. Professions such as tax preparation do not meet this standard.

This relief is most relevant for occupations such as musicians. While musicians may ultimately be classified as SSTBs, they may still claim the tips deduction during the transition period until guidance is issued and becomes effective.

Notice 2025-69 provides transition relief that applies only to the 2025 tax year. The One Big Beautiful Bill Act imposed detailed reporting requirements for tips and overtime on Forms W-2 and 1099. While the IRS has updated those forms for 2026, it did not update them for 2025, creating a reporting gap. Notice 2025-69 explains how taxpayers may claim deductions during this interim period.

For employees, qualified tips for 2025 may be determined using any of the following:

• Social Security tips reported in Box 7 of Form W-2

• Eligible tips separately reported in Box 14 of Form W-2

• Total tips reported to the employer on Forms 4070 for the year

• Tips reported by the employee on Form 4137 and attached to the return

These amounts may be combined to determine qualified tips for Schedule 1-A.

For self-employed taxpayers, the IRS allows the use of any reasonable method to substantiate tips for 2025. Acceptable documentation includes earnings statements, receipts, point-of-sale records, daily tip logs, or other records supporting the amounts reported.

The regulations include an example involving Donna, a self-employed travel guide. Donna received $17,000 in tips through a third-party settlement organization and received a Form 1099-K showing $95,000 in total payments, with tips not separately identified. Because Donna maintained a detailed daily log substantiating her tips, she may claim $17,000 as qualified tips on Schedule 1-A for 2025.

A critical limitation applies to self-employed taxpayers: tips must be reported through a Form 1099 or third-party payment system. Cash tips do not qualify for the deduction, even if the taxpayer maintains a tip log. This creates a compliance issue for many service providers who traditionally receive tips in cash.

For 2026, draft Forms 1099-NEC, 1099-MISC, 1099-K, and Form W-2 include new fields for cash tips and a Treasury Tip Occupation Code. These codes apply to industries that customarily and regularly received tips on or before December 31, 2024. The full list of qualifying occupations was previously published in IRS guidance and summarized in prior

materials.

All draft forms include lines for overtime compensation except Form 1099-K, raising unresolved questions for self-employed taxpayers. Under the regulations, self-employed taxpayers are eligible for both the tips and overtime deductions, but the rules provide limited guidance on how overtime will be reported or substantiated on Forms 1099-NEC or 1099-MISC.

For 2025 overtime deductions, employees may use any reasonable method if the employer does not provide qualified overtime information. Pay stubs may be used, but only the premium portion of overtime pay qualifies. Only overtime calculated under the Fair Labor Standards Act is eligible. State-specific overtime rules, such as daily overtime under California law, do not qualify unless the employee worked more than 40 hours in the week.

The IRS has also provided transition relief for payors. Employers and 1099 issuers will not be subject to penalties for failing to separately report tips and overtime for 2025, although they are encouraged to do so.

Significant open questions remain for 2026, including:

• How payors must separately report tips on Forms 1099-NEC and 1099-MISC

• Whether corrected forms may be required if tips are not separately stated

• How overtime will be reported for self-employed individuals

Tips and Overtime Deductions for 2025 and 2026Transition Relief