Above-the-line deductions for qualified tips and FLSA overtime premium pay under the One Big Beautiful Budget Act. Tax years 2025-2028. For CPAs and enrolled agents.
IRC 224 and IRC 225, enacted as part of the One Big Beautiful Budget Act (OBBBA), establish two new above-the-line deductions: a deduction for qualified tips under IRC 224 and a deduction for qualified overtime compensation under IRC 225. Both deductions reduce adjusted gross income (AGI) directly, without requiring the taxpayer to itemize. They apply to tax years beginning after December 31, 2024, and are subject to a mandatory sunset on December 31, 2028, unless Congress acts to extend them.
This guide is intended for CPAs, enrolled agents, and tax attorneys advising clients in industries affected by the new provisions. The IRS issued proposed regulations on September 22, 2025, defining qualifying occupations for IRC 224 and transition rules for both provisions. IRS Notice 2025-69 (November 21, 2025) provides penalty relief for 2025 transition-year withholding failures related to IRC 225. Both documents remain interim authority; practitioners should verify current status at IRS.gov before advising clients.
IRC 224 and IRC 225 expire for tax years beginning on or after January 1, 2029. Unless Congress extends these provisions, clients who plan multi-year compensation arrangements around the deductions face a hard cliff. Verify current sunset status at IRS.gov and monitor Congress.gov for extension legislation.
Practitioners must distinguish between the two deductions, which have different eligibility rules, different dollar caps, and different populations of qualifying taxpayers. IRC 224 reaches both employees and self-employed individuals in qualifying tipped occupations; IRC 225 is limited to employees covered by the Fair Labor Standards Act (FLSA) and does not extend to independent contractors or the self-employed.
Both deductions incorporate the specified service trade or business (SSTB) exclusion from IRC 199A(d)(2), meaning clients in fields such as law, accounting, health, consulting, and financial services are categorically disqualified from either deduction, even if they receive tips or overtime pay.
Under IRC 224(d)(1), a "qualified tip" is a payment that meets all four of the following conditions:
Mandatory service charges added by the employer, tip pools distributed from employer-controlled surcharges, and auto-gratuities imposed on large parties are not qualified tips under this definition, regardless of the label applied by the employer.
The list of qualifying tipped occupations is based on the IRS proposed regulations issued September 22, 2025, and is locked to occupations that were customarily tipped as of December 31, 2024. Occupations that emerged as commonly tipped after that date do not qualify. Final regulations have not been issued as of the date of this guide. Confirm occupational eligibility against the most current IRS guidance at IRS.gov and consult independent counsel before advising clients in occupations not clearly listed.
Workers in specified service trades or businesses (SSTBs) as defined in IRC 199A(d)(2) do not qualify for the IRC 224 deduction. The SSTB categories include, but are not limited to: law, accounting, health (including physicians, dentists, and veterinarians), actuarial science, performing arts, consulting, athletics, financial services, brokerage services, and any trade or business where the principal asset is the reputation or skill of the owner or employees.
Clients in specified service trades, including attorneys, CPAs, financial advisors, consultants, and health care providers, are excluded from both IRC 224 and IRC 225 even if they receive tips or overtime pay. Practitioners should classify each client's principal occupation before assuming either deduction is available. Mixed-service situations (where a client operates both a qualifying and a disqualifying trade or business) require careful analysis under IRC 199A(d)(2) standards. Verify SSTB classification at IRS.gov and consult independent counsel.
The IRC 224 deduction is capped at $25,000 per tax year. The deduction is reduced dollar-for-dollar beginning at the following modified adjusted gross income (MAGI) thresholds (verify current figures at IRS.gov):
The phaseout is dollar-for-dollar, meaning each dollar of MAGI above the threshold reduces the available deduction by one dollar. A single filer with $175,000 MAGI would have the $25,000 cap reduced by $25,000 to zero, eliminating the deduction entirely. The phaseout applies independently from the IRC 225 phaseout computation.
The IRC 224 phaseout and the IRC 225 phaseout are computed independently using the same MAGI figure but applied to each deduction's available limit separately. A taxpayer claiming both deductions must run two separate phaseout calculations. Do not combine the deduction limits before applying the phaseout.
IRC 224 reaches both W-2 employees and self-employed individuals, provided the occupation test and SSTB test are met. Key distinctions:
Note that self-employed individuals and independent contractors who also perform services within an SSTB remain excluded from IRC 224 for those SSTB activities. Verify at IRS.gov.
The single most important technical point under IRC 225 is that only the overtime premium qualifies, not the full amount of overtime pay. Under the Fair Labor Standards Act, covered employees who work more than 40 hours in a workweek must be paid at least 1.5 times their regular rate for each overtime hour. IRC 225 treats as qualified overtime compensation only the additional 0.5 multiplier (the "half" of "time and a half") -- not the underlying regular-rate portion of overtime hours.
IRC 225 deducts only the overtime PREMIUM (the extra 0.5 multiplier above the regular rate), not the full amount paid for overtime hours. If an employee earns $24 per hour and works 5 overtime hours, the gross overtime pay is $180 (1.5 x $24 x 5). Only $60 (0.5 x $24 x 5) is the deductible premium under IRC 225. The remaining $120 (the regular-rate component) is ordinary wage income. Claiming the full $180 as the IRC 225 deduction is an error. Confirm calculation methodology with IRS.gov guidance before filing.
IRC 225 applies exclusively to employees subject to FLSA overtime requirements. Self-employed individuals, sole proprietors, partners, and independent contractors are not covered by the FLSA overtime rules and therefore cannot claim the IRC 225 deduction, regardless of whether they work more than 40 hours per week. There is no equivalent overtime deduction for self-employed persons under the OBBBA. Verify at IRS.gov.
The same IRC 199A(d)(2) SSTB exclusion that applies to IRC 224 also applies to IRC 225. An employee whose principal occupation falls within a specified service trade or business (law, accounting, health, consulting, financial services, etc.) is disqualified from the IRC 225 deduction even if they receive FLSA overtime pay from an SSTB employer. Verify at IRS.gov and consult independent counsel.
The IRC 225 deduction cap differs by filing status (verify current figures at IRS.gov):
The phaseout mirrors IRC 224 in structure but is computed independently. The dollar-for-dollar phaseout begins at $150,000 MAGI (single) and $300,000 MAGI (MFJ). A single filer with $162,500 MAGI would have the $12,500 cap reduced by $12,500 to zero, fully eliminating the deduction. A married filer would need $25,000 of MAGI above $300,000 to fully phase out the $25,000 MFJ cap.
IRC 225 is effective only for tax years beginning after December 31, 2024, and before January 1, 2029. It expires on December 31, 2028, unless Congress enacts an extension. Practitioners should factor the sunset into any compensation planning advice involving FLSA overtime structures.
A tipped employee who also earns FLSA overtime may claim both IRC 224 and IRC 225 in the same tax year. The deductions do not reduce each other, and the limits are applied independently:
A single filer who receives $20,000 in qualified tips and $10,000 in overtime premium pay (and who is below the phaseout threshold) may deduct up to $30,000 in total above the line -- $20,000 under IRC 224 and $10,000 under IRC 225. Both deductions are reported on Schedule 1-A.
Because the phaseouts are computed separately, a taxpayer near the threshold should model both phaseouts independently. For example, a single filer with $158,000 MAGI, $25,000 in qualified tips, and $12,500 in overtime premium:
The phaseout must not be applied as a single combined computation. Verify current phaseout mechanics at IRS.gov before filing.
Employees eligible for IRC 224 and IRC 225 deductions may have excess withholding during the year unless they adjust their Form W-4. Because both deductions reduce taxable income above the line, the employee's effective tax liability may be materially lower than the amount withheld on wages that include tips and overtime. Practitioners advising affected employees should:
For 2025, employers are also dealing with transition-year payroll system adjustments. IRS Notice 2025-69 provides penalty relief for certain withholding failures in 2025, recognizing that payroll systems needed time to separately identify the overtime premium component.
IRS Notice 2025-69, issued November 21, 2025, provides penalty relief for employers who fail to separately track and withhold on the overtime premium during 2025. The notice acknowledges that payroll systems require time to distinguish between the regular-rate and premium-rate portions of overtime pay for withholding purposes. Practitioners advising employers should:
IRS Notice 2025-69 (November 21, 2025) provides penalty relief for employers who could not separately report the overtime premium on payroll systems during the 2025 transition year. This is the first tax year IRC 224 and IRC 225 apply. Employers who relied on pre-existing payroll configurations for 2025 may cite this notice in response to withholding penalty assessments. Confirm the scope and conditions of this relief at IRS.gov before relying on it. The relief does not extend to misidentification of the full overtime pay as the deductible premium.
Employers must separately identify and report overtime premium pay on Form 941 to the extent required by IRS guidance issued under Notice 2025-69 and any subsequent instructions. The Form 941 deposit schedule and penalty structures under IRC 6656 are unchanged by the OBBBA; the new obligations are additive. Employers with large tip-reporting workforces should also review compliance with existing large food and beverage establishment reporting requirements under IRC 6053.
Employers are expected to separately report qualified tip amounts and overtime premium pay on Form W-2 so that the employee can accurately complete Schedule 1-A. The specific W-2 box designations are subject to IRS guidance still being issued as of the date of this guide. Practitioners should confirm current W-2 reporting instructions with the IRS Instructions for Forms W-2 and W-3 and coordinate with payroll providers before year-end processing.
Both IRC 224 and IRC 225 deductions are reported on Schedule 1-A, the new above-the-line deduction form created under the OBBBA. Schedule 1-A feeds into Schedule 1 (Additional Income and Adjustments), which in turn reduces the Form 1040 AGI. Practitioners should confirm the current version of Schedule 1-A at IRS.gov, as the form instructions may be updated to reflect final regulations.
The table below compares the key mechanical features of IRC 224 (qualified tips) and IRC 225 (qualified overtime compensation). Verify all figures and rules at IRS.gov before advising clients.
| Feature | IRC 224 -- Qualified Tips | IRC 225 -- Qualified Overtime Compensation |
|---|---|---|
| Deduction type | Above-the-line (reduces AGI before itemizing) | Above-the-line (reduces AGI before itemizing) |
| Eligible recipients | W-2 employees, self-employed individuals, and independent contractors in qualifying tipped occupations (non-SSTB) | W-2 employees only; FLSA overtime coverage required; no self-employed or contractor eligibility |
| Deduction limit | $25,000 per year (verify at IRS.gov) | $12,500 single / $25,000 MFJ per year (verify at IRS.gov) |
| Phaseout threshold | Dollar-for-dollar beginning at $150,000 MAGI (single) / $300,000 MAGI (MFJ) (verify at IRS.gov) | Dollar-for-dollar beginning at $150,000 MAGI (single) / $300,000 MAGI (MFJ) (verify at IRS.gov) |
| SSTB exclusion | Yes -- IRC 199A(d)(2) SSTBs excluded; law, accounting, health, consulting, financial services, etc. | Yes -- same IRC 199A(d)(2) SSTB definition applies |
| Sunset date | Expires December 31, 2028, unless Congress extends (verify at IRS.gov) | Expires December 31, 2028, unless Congress extends (verify at IRS.gov) |
| Primary IRS authority | IRC 224; IRS Proposed Regulations (September 22, 2025); IRS Notice 2025-69 | IRC 225; IRS Notice 2025-69 (withholding and employer reporting) |
| Withholding impact | Employee should update Form W-4 to reflect anticipated deduction; employer tracks tip income on payroll | Employer must separately identify overtime premium for withholding; Notice 2025-69 provides 2025 transition relief |
| Reporting form / schedule | Schedule 1-A (new OBBBA deductions schedule); carried to Schedule 1 and Form 1040 | Schedule 1-A; employer reports on Form W-2 (box designations per current IRS instructions) |
| Stacking with the other deduction allowed | Yes -- a tipped employee who earns FLSA overtime may claim both IRC 224 and IRC 225; limits are separate | Yes -- a tipped overtime-eligible employee may claim both; phaseouts computed independently |
| Self-employed / contractor eligibility | Yes -- self-employed individuals and contractors in qualifying tipped occupations are eligible (subject to occupation and SSTB tests) | No -- self-employed and independent contractors are categorically ineligible; FLSA does not apply to them |
Qualifying occupations are those that were customarily and regularly tipped as of December 31, 2024. The IRS proposed regulations issued September 22, 2025, define the occupation list and lock it to that date. Examples of customarily tipped occupations include food and beverage service workers, hotel housekeepers, barbers, cosmetologists, nail technicians, and similar service workers. Occupations not commonly recognized as tipped as of December 31, 2024, do not qualify even if gratuities are now common in that field.
Workers in SSTBs under IRC 199A(d)(2) are excluded. Verify the current qualifying occupation list at IRS.gov. Consult independent counsel before advising clients in borderline occupations, as final regulations remain pending as of the date of this guide.
Yes. A tipped employee who also earns FLSA-qualifying overtime may claim both IRC 224 and IRC 225 in the same tax year. The deduction limits are independent: up to $25,000 in qualified tips under IRC 224, and up to $12,500 (single) or $25,000 (married filing jointly) in overtime premium pay under IRC 225.
The phaseout thresholds, beginning at $150,000 MAGI (single) or $300,000 MAGI (MFJ), apply separately to each deduction. Both deductions are reported on Schedule 1-A. Verify current figures at IRS.gov before advising clients on combined strategies.
No. IRC 225 applies exclusively to employees who receive overtime compensation governed by the Fair Labor Standards Act (FLSA). Self-employed individuals and independent contractors are not subject to FLSA overtime requirements and therefore do not qualify for the IRC 225 deduction.
Self-employed individuals in qualifying tipped occupations may, however, be eligible for the IRC 224 qualified tips deduction if they meet the occupation test and SSTB test. Verify at IRS.gov and consult independent counsel.
Both IRC 224 and IRC 225 incorporate the specified service trade or business (SSTB) exclusion from IRC 199A(d)(2). Workers whose principal occupation falls within an SSTB -- including law, accounting, health, consulting, financial services, brokerage, performing arts, athletics, and actuarial science -- are disqualified from both deductions regardless of whether they receive tips or FLSA overtime pay.
The SSTB classification turns on the taxpayer's primary business activity. Mixed-service situations, where a client operates both a qualifying and a disqualifying trade or business, require case-by-case analysis under IRC 199A standards. Verify at IRS.gov and consult independent counsel before advising clients in borderline occupations.
Only the additional premium portion of overtime pay qualifies under IRC 225. Under the FLSA, overtime is paid at 1.5 times the regular rate. Only the 0.5 multiplier (the half-time premium above the regular rate) constitutes qualified overtime compensation under IRC 225. The regular-rate portion of overtime hours is ordinary wage income and is not deductible under IRC 225.
Example: An employee earns $20 per hour and works 10 overtime hours. Total overtime pay: $20 x 1.5 x 10 = $300. IRC 225 deductible overtime premium: $20 x 0.5 x 10 = $100. The remaining $200 (regular rate for the overtime hours) is not deductible under IRC 225. Misidentifying the full $300 as the deductible amount is the most common practitioner error. Verify current calculation methodology at IRS.gov.
Both deductions phase out on a dollar-for-dollar basis beginning at $150,000 MAGI for single filers and $300,000 MAGI for married filing jointly (verify current figures at IRS.gov). Each phaseout is computed independently using the same MAGI figure but applied separately to each deduction's available limit.
A single filer with $162,500 MAGI loses $12,500 of IRC 224 capacity (capping available IRC 224 deduction at $12,500) and loses $12,500 of IRC 225 capacity (eliminating the $12,500 single-filer IRC 225 cap entirely). Do not combine the two limits before applying the phaseout calculation.
Employers must separately identify and report qualified tips and overtime premium pay on Form W-2 so the employee can accurately complete Schedule 1-A. Specific W-2 box designations for IRC 225 overtime premium reporting are subject to IRS guidance still pending finalization as of the date of this guide.
IRS Notice 2025-69 (November 21, 2025) provides penalty relief for employers who failed to separately report overtime premium pay during the 2025 transition year. Employers should confirm current W-2 reporting instructions with the IRS Instructions for Forms W-2 and W-3, coordinate with payroll providers before year-end processing, and verify at IRS.gov. Failure to separately track the overtime premium creates downstream errors on the employee's Schedule 1-A.
Both IRC 224 and IRC 225 contain mandatory sunset provisions. They are effective only for tax years beginning after December 31, 2024, and before January 1, 2029. Unless Congress enacts legislation to extend or make these provisions permanent, both deductions expire for tax years beginning on or after January 1, 2029.
Practitioners should advise clients of the sunset, factor the expiration date into multi-year compensation planning, and monitor legislative developments at IRS.gov and Congress.gov. Clients who structure compensation arrangements in reliance on these deductions should have contingency plans if the sunset is not extended.
AmericasTax.com provides practitioner-level resources for CPAs, enrolled agents, and tax attorneys navigating OBBBA provisions. Confirm all figures and eligibility rules at IRS.gov before advising clients.
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