IRS Grants Employers Penalty Relief for 2025 Tip and Overtime Reporting

11 Dec 2025 IRS Grants Employers Penalty Relief for 2025 Tip and Overtime Reporting

The IRS is offering employers a break for 2025, easing penalties as businesses work to comply with new reporting rules for tips and overtime pay. In Notice 2025-62, released November 5, the IRS acknowledged that many employers aren’t ready to meet the reporting obligations introduced under the One, Big, Beautiful Bill Act (OBBBA).

This relief is especially important for employers with tipped workers or those who pay overtime, though it comes with clear limits and expectations.

OBBBA changes to tips and overtime

To appreciate why this penalty relief matters, it’s helpful to understand what changed. The OBBBA, which became law in July 2025, introduced two major provisions affecting workers and their employers. These provisions are effective for tax years 2025 through 2028, creating a four-year window during which special deductions apply.

The first provision, commonly called “No tax on tips,” allows employees and self-employed individuals in certain tipped occupations to deduct up to $25,000 of qualified tips annually on their individual tax returns. This isn’t a credit or exclusion from wages for employment tax purposes; rather, it’s a deduction that workers claim on Form 1040, similar to other above-the-line deductions. The deduction is available regardless of whether the taxpayer itemizes or takes the standard deduction. However, the benefit phases out at higher income levels, and not all tips qualify.

The second provision, “No tax on overtime,” provides a similar benefit for overtime compensation. Workers can deduct up to $12,500 of qualified overtime pay annually, or $25,000 for married couples filing jointly. Like the tips provision, this deduction is claimed on the individual’s tax return and is subject to income limitations and eligibility requirements.

The new reporting burden on employers

While the OBBBA ultimately requires employers to separately report qualified tips and overtime compensation on information returns like Forms W-2, 1099, and 1099-K, these requirements do not apply for tax year 2025.

Instead, the IRS has granted a one-year transition period, waiving penalties for failure to provide separate reporting of these amounts or the applicable occupation codes. That said, employers will need to comply with the full reporting requirements beginning in 2026.

What the penalty relief covers

For 2025 only, the IRS won’t impose penalties under IRC §§6721 or 6722 for failing to separately report:

• Qualified tips
• Qualified overtime
• Occupation codes

But this relief applies only if employers file accurate and timely returns otherwise. It’s not a waiver for missing filings or incorrect wage reporting.

What employers can do now

Even with penalty relief in place, the IRS strongly encourages employers to voluntarily provide employees with the information they need to claim the new deductions for qualified tips and overtime.

While the standard tax forms for 2025 won’t include specific fields for this data, there are still several practical ways to communicate it. One option is to use Box 14 of Form W-2 to report qualified overtime amounts, labeled appropriately.

Employers can also issue supplemental written statements alongside W-2s or 1099s, or establish secure online portals that give employees access to detailed breakdowns of their compensation. For businesses with tipped workers, it’s important to include the relevant occupation codes along with the reported tip amounts so employees can determine whether they qualify for the deduction.

Preparing for 2026 compliance

The extra time offers employers a chance to prepare for full compliance:

• Assess payroll systems to identify gaps and needed updates
• Work with software providers on timelines for compliant reporting
• Review IRS occupation codes and match them to your workforce
• Develop tracking processes for qualifying tips and overtime
• Train payroll and HR staff on definitions, eligibility, and reporting standards

Complex businesses, especially those with tipped workers performing multiple roles, may need outside help to apply codes correctly and track eligible compensation.

Looking ahead

More IRS guidance for individual taxpayers is expected soon, covering how to claim the new deductions on 2025 returns. For 2026 and beyond, tax forms will likely be updated with new boxes for qualified tips, overtime, and occupation codes.

And because these provisions are set to expire after 2028, employers need systems that can adapt if the rules are extended, revised, or sunset.

Bottom line: the IRS has given employers breathing room for 2025, but the clock is ticking. Start preparing now to ensure full compliance in 2026. For guidance tailored to your business, contact our office.

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