Options for Claiming the 2025 Deductions for Tips and Overtime

Under Notice 2025-62, the Internal Revenue Service has issued guidance clarifying how employers and employees should document and report qualified tips and qualified overtime compensation for the 2025 tax year. This notice is especially important for businesses in service-heavy and labor-intensive industries where tips and overtime wages make up a significant portion of employee compensation.

The guidance focuses on documentation standards, employer reporting responsibilities, and the options available when claiming deductions or exclusions related to these amounts.

Why Notice 2025-62 Matters

For years, tips and overtime have been subject to heightened scrutiny because of inconsistent reporting practices. Notice 2025-62 is intended to:

• Improve consistency in how qualified tips and overtime are tracked

• Reduce disputes during audits

• Ensure deductions and exclusions are properly substantiated

• Align payroll systems with updated reporting expectations

In short, the IRS is signaling that documentation matters more than ever starting with 2025 returns.

What Counts as “Qualified Tips” in 2025

Under the guidance, qualified tips generally include cash and charged tips received directly from customers in the ordinary course of employment. To be considered qualified:

• Tips must be reported by the employee to the employer

• The employer must maintain contemporaneous records

• Tips must be properly reflected in payroll and wage reporting

Employers should ensure tip-reporting systems—whether point-of-sale based or manual—capture employee-reported tips accurately and retain records that support amounts shown on Forms W-2 and related payroll filings.

What Counts as “Qualified Overtime Compensation”

Qualified overtime compensation refers to the premium portion of wages paid for hours worked beyond standard thresholds, such as time-and-a-half pay. Under Notice 2025-62:

• Only the overtime premium portion is treated as qualified

• Employers must distinguish base wages from overtime premiums

• Payroll records must clearly show hours worked and rates applied

This distinction is critical. Poorly structured payroll systems that lump all wages together may jeopardize the ability to properly support deductions or exclusions tied to overtime pay.

Documentation Options for Employers

Notice 2025-62 allows flexibility in how employers document qualified tips and overtime, but the records must be reliable, consistent, and retained. Acceptable documentation methods include:

• Payroll system reports showing wage breakdowns

• Time-tracking systems that record regular and overtime hours

• Employee tip reports submitted daily or per pay period

• Point-of-sale summaries reconciled to payroll records

Employers are encouraged to review their systems now, rather than waiting until year-end, to ensure they can produce the required substantiation if questioned.

Reporting on 2025 Tax Returns

For 2025 returns, employers must ensure:

• Qualified tips and overtime are properly categorized in payroll records

• Amounts reported on wage statements match internal documentation

• Any deductions or exclusions claimed are fully supported

Employees, meanwhile, should expect clearer wage statements that separately identify tip income and overtime premiums, helping reduce confusion when filing individual returns.

Practical Steps to Take Now

To prepare for compliance under Notice 2025-62, employers should consider:

• Reviewing payroll and POS systems for proper wage classification

• Updating internal policies for tip and overtime reporting

• Training managers and payroll staff on the new guidance

• Conducting a mid-year documentation check before 2025 ends

Proactive planning can help avoid adjustments, penalties, or disputes down the road.

Final Thoughts

Notice 2025-62 represents a continued push by the IRS toward transparency and consistency in wage reporting. While the guidance does not radically change the tax treatment of tips or overtime, it raises the bar for documentation.

For businesses that rely heavily on tipped employees or overtime labor, now is the time to ensure payroll practices are audit-ready. Clear records, consistent processes, and early adjustments can make the difference between a smooth filing season and an expensive compliance issue.