Tips, Overtime Pay and Payroll for 2025

The new Federal income tax deductions are effective for income earned starting January 1, 2025. This may have an impact on how payroll reports tips and overtime pay when providing 2025 census data. Note that payroll does not yet have full guidance about the new rules.

The new law is much more complicated that one would think.  It creates a Federal deduction for tips that can be taken on a personal income tax form.  It does not exclude tips from all payroll taxes.  The exclusion is solely for Federal income taxes.  Tips are subject to Social Security and Medicare taxes, and any applicable State and Local taxes.

There is a cap of $25,000 on the amount of tips that are deductible, and this phases out as income rises above $150,000 (for single filer) and phases out if income reaches $400,000 (for single filer).

Not all occupations qualify for the tips deduction. The IRS is required to publish a list of occupations eligible for the tips deduction by October 2, 2025.  If you earn tips in an occupation that does not appear on the list (when it is published), you get no tips deduction.

While you are looking at income taxes, also keep in mind that there is a new deduction up to $12,500 (for single filer) available on overtime pay.

*Re-posted from 401(k)/Tips*

Thanks for the insight Paul. I assume these new deductions would not have any affect on plan compensation? 

The deductions should not affect a plan's definition of compensation (unless there is special language in the document that somehow manages to cross the line).

My primary concern is that payroll to needs to track and report to the employees some new information.  It seems every year payroll is saddled with additional reporting requirements, there is an increase in errors on reporting plan compensation.  These particular provisions are retroactive to 1/1/2025, and payroll typically does handle retroactive changes very well.

The IRS published on August 7 some indications of will be required to be tracked by payroll.  https://www.irs.gov/newsroom/one-big-beautiful-bill-act-of-2025-provisions

Notably, regarding tips:

"Reporting: Employers and other payors must file information returns with the IRS (or SSA) and furnish statements to taxpayers showing certain cash tips received and the occupation of the tip recipient.

Guidance: By Oct. 2, 2025, the IRS must publish a list of occupations that “customarily and regularly” received tips on or before Dec. 31, 2024.

    The IRS will provide transition relief for tax year 2025 for taxpayers claiming the deduction and for employers and payors subject to the new reporting requirements."

and regarding overtime:

"Reporting: Employers and other payors are required to file information returns with the IRS (or SSA) and furnish statements to taxpayers showing the total amount of qualified overtime compensation paid during the year.

Guidance: The IRS will provide transition relief for tax year 2025 for taxpayers claiming the deduction and for employers and other payors subject to the new reporting requirements."

Here's an article that identifies some of the issues and transition relief for employers (albeit not specifically related to retirement plans).