IRS Grants 2025 Penalty Relief on Tip and Overtime Reporting

The U.S. Department of the Treasury and Internal Revenue Service (IRS) has issued long-awaiting guidance in connection with the new reporting requirements imposed by the One, Big, Beautiful Bill Act (OBBBA) that President Donald J. Trump signed into law in July. During his run for a second term, President Trump pledged to eliminate taxes for tips earned by waiters, waitresses and other service workers who customarily receive tips. The bill that eventually was signed into law permits such workers to deduct up to $25,000 per year in tips from the federal taxable income.

In response to the uncertainty created by the law’s imposition of heightened reporting requirements for cash tips and overtime compensation, the IRS issued guidance providing penalty relief to employers for the 2025 tax year in connection with these reporting requirements.

Deductions & Reporting Requirements

OBBBA introduced major tax deductions for workers, including above-the-line deductions for “qualified tips” and “qualified overtime compensation.” While these deductions are intended to increase take-home pay for many Americans, they create new compliance burdens for employers. Specifically, facilitating these deductions demands that employers comply with more rigorous reporting obligations. This is especially true for employers in industries such as hospitality, retail, and healthcare, where tips and overtime pay are routine.

Prior to issuance of the IRS guidance, the new law created uncertainty for employers required to implement updated reporting processes, particularly when a failure to do so exposed them to penalties. In response to such uncertainty, the IRS acknowledged the complexities of navigating the new reporting requirements and issued Notice 2025-62.

The guidance from Notice 2025-26 temporarily relieves employers of the penalties imposed for a failure to provide separate accounting of any amounts reasonably designated as cash tips, the occupation of the person receiving tips, or the qualified overtime paid to an employee. It eases the burden on businesses—notably those in sectors where employees frequently receive tips or overtime pay—by granting much-needed relief and flexibility during this period of transition.

Why Relief Matters

OBBBA requires employers to report the following information for each employee on Form W-2:

• The total amount of cash tips reported by the employee.
• The employee’s tipped occupation.
• The amount of qualified overtime compensation paid to the employee.

However, the law failed to address concerns raised by the new reporting requirements. Employers received no guidance on calculating qualified overtime compensation, nor were they provided clarity on where to report this information on Form W-2. This uncertainty was further complicated by the IRS announcement that Form W-2 will remain unchanged for the 2025 tax year.

Implementing OBBBA’s reporting requirements—without guidance to employers—has posed significant practical compliance issues, particularly for those businesses who lack the systems and procedures necessary to accurately collect and report this data for the 2025 tax year.

Notice 2025-62 temporarily addresses these time-sensitive concerns and buys employers additional time to acclimate to the new reporting requirements. In providing penalty relief to affected employers, Notice 2025-26 offers meaningful support to businesses as they adapt their systems and processes in anticipation of updated reporting forms in 2026. Importantly, employers have additional time to navigate the complexities of the new law’s reporting requirements, and they can rest assured that they will not be penalized for their failure to adequately report during this transition period.

What Now? Employer Best Reporting Practices for the 2025 Tax Year

Though employers will not face penalties for failing to provide a separate accounting of amounts designated as cash tips, the occupation of the person receiving such tips, or the amount of qualified overtime compensation, the relief applies only to the extent that the person files and provides a complete and correct return or statement.

The IRS encourages employers during this transition period to take these steps proactively:

• Provide employees in tipped occupations with their occupation.
• Provide employees in tipped occupations with an accounting of their cash tips.
• Provide employees with an accounting of their qualified overtime compensation.

Employers should be aware that qualified employees will expect to receive this information to claim OBBBA’s above-the-line deductions for qualified tips and overtime when filing their 2025 tax returns. For this reason, the IRS encourages employers to share this information with its employees via online portals, supplemental written statements, or other secure methods.

In the case of qualified overtime compensation, employers can also make this information available to employees by including it in box 14 of Form W-2.

Key Takeaways for Employers

Employers should bear in mind that:

• For 2025, they are not penalized for failing to separately report cash tips, tip occupations, and qualified overtime compensation under OBBBA, if all other required information is provided.
• They should still make every effort to provide employees with this information to facilitate their deductions.
• Updated forms and stricter requirements are expected for 2026, requiring advance planning and potential system upgrades where necessary.

Looking Forward: 2026 and Beyond

Employers must be mindful that Notice 2025-62’s relief applies only to the 2025 tax year. Beginning in 2026, employers will be required to comply with the new law’s reporting requirements, and they can expect to see updates to Forms W-2, reflecting the OBBBA mandates.

Preparation for 2026 is critical, as employers risk facing penalties in the next calendar year for failure to comply with OBBBA’s updated reporting requirements. Employers should use the transition year to implement or upgrade payroll systems, train staff, and consult employment counsel to ensure readiness for the more stringent reporting standards that will apply from January 1, 2026.

Please contact Fallon A. Voltolina or any member of Phelps’ labor and employment team if you have questions or need advice or guidance.