IRS Transition Relief Eases Compliance for 2025

With the passage of the One, Big, Beautiful Bill Act (OBBBA), individual taxpayers can now benefit from new federal income tax deductions for qualified tips and qualified overtime compensation. Recognizing the challenges of implementing these changes, the IRS has announced important transition relief for the 2025 tax year. This relief means that, for 2025, employers and payors are not required to separately report tips or overtime on standard tax forms, and taxpayers can rely on reasonable methods and existing documentation to claim these deductions. This approach is designed to simplify compliance while final regulations and updated forms are being developed for future years.

Determining Qualified Tips

For the 2025 tax year, the IRS has issued guidance allowing employees to claim the qualified tip deduction even if cash tips are not separately listed on Form W-2. To start, employees must verify that their job was one that customarily and regularly received tips as of December 31, 2024. To figure out your qualified tips, you can use the following sources:

• Social Security tips reported in Box 7 of your Form W-2.
• Cash tips your employer voluntarily reported in Box 14 of Form W-2 or on a separate statement.
• Any amount shown on Line 4 of Form 4137 (Social Security and Medicare Tax on Unreported Tip Income) filed with your 2025 tax return and included in your income.
• Tips you reported to your employer on Forms 4070 (Employee’s Report of Tips to Employer) or similar substitute forms.

Qualified Tips Deduction – Examples

Example 1: Restaurant Server

• Scenario: Employee A works as a server in a busy restaurant. Throughout 2025, A receives cash and credit card tips from customers, which are reported to the employer as required.
• Application: For the 2025 tax year, A’s Form W-2 shows $18,000 in box 7 (“Social Security Tips”). Because the IRS transition relief allows employees to use the total in box 7—even though the form does not separately account for tips under the new law—A can claim a deduction for the full $18,000 as qualified tips, provided all other requirements are met (such as working in an occupation that customarily received tips before December 31, 2024).

Example 2: Bartender with Additional Tips

• Scenario: Employee B works as a bartender and reports $20,000 in tips to their employer using monthly tip reports (Forms 4070). B’s Form W-2 for 2025 shows $15,000 in box 7, but B also has $4,000 in unreported tips, which are included on Form 4137 and added to B’s income on Form 1040.
• Application: For 2025, B can choose to use either the $15,000 from box 7 of Form W-2 or the $20,000 reported to the employer on Forms 4070 as the base for the deduction. Additionally, B can include the $4,000 of unreported tips from Form 4137, line 4, in the total deduction amount. This flexibility is possible due to the IRS transition relief, which allows reasonable methods for substantiating tip income in the absence of new reporting requirements.

Example 3: Self-Employed Travel Guide

• Scenario: Individual D operates as a sole proprietor travel guide, receiving $7,000 in tips from customers via a third-party payment platform. The Form 1099-K received from the platform shows $55,000 in total payments but does not separately identify tips.
• Application: For 2025, D can rely on daily tip logs and other supporting documentation (such as receipts or point-of-sale system reports) to substantiate the $7,000 in tips received. The IRS transition relief allows D to use these records to calculate the qualified tips deduction, even though the Form 1099-K does not provide a separate accounting of tips.
  
  

How to Calculate Qualified Overtime Compensation

For the 2025 tax year, if qualified overtime compensation is not shown in Box 14 of Form W-2 or on a separate statement, an FLSA-eligible employee may still meet the separate accounting requirement as long as the compensation is correctly reported on Form W-2, Form 1099-NEC, or Form 1099-MISC.

Employees can then calculate the amount of qualified overtime compensation using earnings or pay statements, invoices, or similar documentation, applying a reasonable method.

Qualified Overtime Compensation Deduction – Examples

Example 1: Payroll System Shows Overtime Premium

• Scenario: Individual A is a nonexempt employee whose payroll system tracks overtime pay. In 2025, the payroll system shows that A received $5,000 as an “overtime premium” for hours worked beyond 40 per week.
• Application: For the 2025 tax year, A can claim a deduction for the full $5,000 as qualified overtime compensation. The IRS transition relief allows employees to use payroll records or pay stubs that separately account for the overtime premium, even if this information is not reported in a dedicated box on Form W-2.

Example 2: Aggregate Overtime Amount

• Scenario: Individual A’s pay stub for 2025 shows a total “overtime” amount of $15,000. This figure includes both the overtime premium and the regular wages for overtime hours, but does not break out the premium separately.
• Application: Under the IRS guidance, A can use one-third of the aggregate overtime amount ($5,000) as the deductible FLSA Overtime Premium. This method is permitted for 2025 due to transition relief, which allows reasonable approximations when separate accounting is unavailable.

Example 3: Higher Overtime Rate

• Scenario: Individual B’s employer pays overtime at twice the regular rate (rather than the standard 1.5x). B’s pay stub shows $20,000 as total overtime pay for 2025.
• Application: For the 2025 tax year, B can use one-fourth of the total overtime amount ($5,000) as the deductible FLSA Overtime Premium. The IRS transition relief provides this fractional method for cases where overtime is paid at a higher rate and separate accounting is not provided.
  
  

Key Points for Taxpayers

• Transition relief allows use of existing forms and reasonable documentation for 2025.
• Maintain thorough records (pay stubs, tip logs, earnings statements) to substantiate deductions.
• Employers and payors are not required to separately report tips or overtime for 2025, but this will change for future years.
• Deductions are subject to annual limits and phase-outs based on income.
  
  

Conclusion

The IRS’s transition relief for 2025 makes it easier for taxpayers to claim new deductions for tips and overtime, even as reporting requirements evolve. By following the practical examples above and maintaining good records, individuals can maximize their tax benefits while staying compliant.

If you have any questions, don’t hesitate to reach out to your Scheffel Boyle CPA to set up a consultation.

On July 4^th, 2025, President Trump signed into law the “One Big Beautiful Bill Act”, a sweeping reconciliation package that includes a broad array of tax provisions affecting individuals, businesses, and international taxpayers.

We want to highlight some of the key provisions and offer preliminary insights into how they may affect your tax planning. Please contact us at your earliest convenience to discuss your situation so we can develop a customized plan. We will continue to closely monitor any potential tax legislation and update you accordingly.

Individual Income Tax Provisions

• Permanent extension of lower tax rates and brackets: The bill makes permanent the individual income tax rates and brackets established by the Tax Cuts and Jobs Act (TCJA) including lower individual tax brackets. The top marginal rate remains at 37%, and inflation adjustments are retained for all but the top bracket.
• Standard Deduction: The nearly doubled standard deduction was made permanent, with additional inflation adjustments.
• Itemized deductions/Pease Limitation repeal: The law permanently removes the Sec. 68 overall limitation on itemized deductions (known as the Pease limitation) and implements a limitation that allows an overall maximum benefit of 35% for the value of a taxpayer’s itemized deductions.
• Child Tax Credit: The law would permanently increase the child tax credit to $2,200 per child with $1,700 being refundable, with inflation adjustments.
• Estate and Gift Tax Exemption: The increased exemption is made permanent and raised to $15 million per individual ($30 million for married couples) in 2026, indexed for inflation.
• SALT Deduction Cap: The state and local tax (SALT) deduction cap is increased from $10,000 to $40,000 per household and would be phased out for taxpayers with modified adjusted gross income (MAG) over $500,000.
• Charitable Deduction for Non-Itemizers: A permanent above-the-line deduction for certain charitable contributions ($1,000 for single filers, $2,000 for joint filers) beginning in 2026.
• No Tax on Tips and Overtime: For 2025-2028, above-the-line deductions are created for qualified tips (In certain occupations) and for overtime premium pay, subject to income and occupation limitations. The deduction for qualified tips is limited to $25,000 per taxpayer, while the deduction for overtime is limited to $12,500 per taxpayer.
• Enhanced Deduction for Seniors: For 2025-2028 a deduction is available for seniors ( age 65+) with income below $75,000 ($150,000 for joint filers).
• Car Loan Interest Deduction: For 2025- 2028 up to $10,000 of interest on loans for U.S. assembled passenger vehicles may be deducted, subject to income phaseouts.
• Moving Expense Deduction: The bill permanently terminates the deduction except for Armed Forces.
• Home Mortgage Interest and Insurance Premiums: The bill would permanent the $750,000 Sec. 163(h)(3) limit on the treatment of mortgage insurance premiums as qualified residence interest. The exclusion of home-equity indebtedness from the definition of qualified residence interest would also become permanent.
• Casualty Loss Deduction for personal Casualties: The Sec. 165(h)(5) limitation on personal casualty loss deductions, under which a casualty loss is deductible only to the extent it Is attributable to a federal declared disaster, would be made permanent.
• Deduction for wagering losses: The law limits the amount of deductible losses to 90% of the taxpayer’s wagering losses only to the extent of winnings.
• Establishment of Trump Accounts: The law creates a new tax-deferred savings account for the benefit of children up until the age of 18, which includes a pilot program where children born between 2025 and 2028 may receive a $1,000 government contribution.
• Other Deductions and Credits: The bill makes permanent or enhances several other deductions and credits, including the adoption credit, employer-provided childcare credit, paid family and medical leave credit, and education-related benefits.

Business Tax Provisions

• QBI Deduction: Sec. 199A qualified business income (QBI) deduction is made permanent, and the deductible amount for each qualified business remains 20%. The phase-in ranges are expanded, making more taxpayers eligible to claim the deduction.
• PTET SALT Deduction: The law does not limit the availability of the pass-through entity ax (PTET) deduction for pass-through entities as it currently exists.
• Bonus Depreciation: 100% expensing (bonus depreciation) for qualified property is permanently restored for property place in service beginning Jan. 19, 2025.
• 179 Expensing: The maximum amount a business may expense is increased to $2.5, million, with the phaseout threshold raised to $4 million, both indexed for inflation after 2025.
• Qualified Production Property” Manufacturing Property”: The law introduces an elective 100% depreciation allowance for qualified production property that is acquired and placed in service between Jan. 19, 2025, and Dec. 31, 2030, restoring full expensing for a broader range of assets.
• R&D Expenditures: The TCJA introduced a requirement that specified research and experimental (R&D) expenditures be capitalized and amortized ratably over a five-year period for tax years after 2021. The law permanently suspends that requirement for domestic research or experimental expenditures paid or incurred in tax years beginning Dec 31,2021. Taxpayers are provided with options to claim deductions for previously capitalized domestic research or experimental expenditure paid before 2025. Foreign R&D would continue to be capitalized and amortized for over 15 years.
• EBL Permanency: The law makes Sec. 461(I) excess business loss (EBL) limitation permanent, which is currently set to expire at the end of 2028.
• Deferred payment of tax on capital gains of certain farmland: The law allows qualified sellers of qualified farmland property to elect to pay tax on these capital gains in four equal annual installments.
• Third-Party Network Transaction Reporting Threshold: The law reverts to the prior rule for Form 1099-K, Payment Card and Third Party Network Transactions, reporting, under which a third-party settlement organization (TPSO) would not be required to report unless the aggregate value of third-party network transactions with respect to a participating payee for the year exceeds $20,000 and the aggregate number of such transactions with respect to a participating payee exceeds 200.
• Form 1099 Reporting Threshold: The law increases the information reporting threshold for certain payments to persons engaged in a trade or business and payments of remuneration for services to $2,000 in a calendar year (from $600), with the threshold amount to be indexed annually for inflation in calendar years after 2026.
• Renewed OZs: The new law establishes a permanent opportunity zone (OZs) policy, with revised eligibility and incentives, including special rules for rural areas.
• Clean Energy and IRS Credits: The law terminates or phases out several clean energy credits from the inflation Reduction Act (IRA) and the 179D deduction.
• Employee Retention Credit (ERC) – The law prohibits payment of 2021 Q3, and Q4 ERC claims as of January 31, 2024, and extends the statute of limitations on ERC claims to six years.

How you can prepare:

This brief summary of key law changes only takes into account a few of the changes in this new law. We recommend reviewing your current tax strategy considering these proposed changes. Our team is available to discuss how these provisions may impact your personal or business tax situation and to help you plan accordingly.

As always, if you have any questions, please contact your trusted Scheffel Boyle CPA to schedule a consultation.