As a follow-up to our earlier communication regarding the newly enacted federal tax deductions for tip income and overtime pay, we want to provide an important update based on the IRS’s initial guidance released on July 14, 2025 (FS-2025-03). These deductions are now in effect as of January 1, 2025, and, while they are claimed by individual employees, employers in the restaurant and hospitality industries will play a central role in determining eligibility and ensuring compliance with the related reporting requirements.

Tip Income Deduction

The tip income deduction will be available only if the employer is not classified as a “Specified Service Trade or Business” (SSTB) under Internal Revenue Code Section 199A. While most restaurant and hospitality businesses are not SSTBs, we encourage you to confirm your business classification. In addition, the deduction applies exclusively to voluntary tips—mandatory gratuities or service charges will disqualify the compensation from eligibility. Employees must also be working in occupations that have “customarily and regularly” received tips prior to 2025. The IRS has indicated that it will publish a list of qualifying occupations by October 2, 2025.

Overtime Deduction

The overtime deduction applies to the premium portion of overtime compensation—that is, the additional amount paid above the employee’s regular hourly rate for overtime hours as defined under the Fair Labor Standards Act. For example, if an employee earns $20 per hour and receives $30 for overtime hours, only the $10 premium is deductible. Employers will be expected to track and report the regular versus premium portions of employee compensation separately, although the specific reporting method has not yet been released.

While additional IRS guidance is forthcoming—including the expected October release of qualifying occupations and further details on required reporting formats—the IRS has confirmed that transition relief will be provided for both employers and employees during the 2025 tax year. Nonetheless, now is the time to prepare. We recommend reviewing your current tip policies to ensure that all tips remain voluntary, confirming your business classification under Section 199A, and assessing whether your payroll systems can accommodate the required tracking for both tip and overtime reporting.

We will continue to monitor developments closely and will provide further updates as the IRS issues additional guidance. In the meantime, please feel free to contact us with any questions or to begin preparing your systems for compliance in 2025.