What guidance has the IRS and North Carolina Department of Revenue issued for reporting and claiming the new tip and overtime deductions?
Executive summary
The Treasury and IRS issued transition guidance allowing workers to claim the new “no tax on tips” and overtime deductions for tax year 2025 even though employer reporting forms were not yet changed, and they signaled that Forms W‑2 and various 1099s will be updated for tax year 2026 to separately show qualified tips and qualified overtime compensation [1] [2]. Reporting relief and practical methods for calculating deductions—plus limits and exclusions—are explained in IRS notices; state action (including North Carolina’s) on whether to conform is uneven, and no detailed North Carolina Department of Revenue (NCDOR) technical guidance was found in the supplied reporting [3] [4].
1. IRS issued immediate taxpayer guidance and a 2025 transition rule
The Treasury and IRS published Notice 2025‑69 and companion materials to tell workers how to determine their tip and overtime deductions for tax year 2025 even though Forms W‑2 and 1099s were not yet revised to show separate amounts; the notices explain acceptable methods for taxpayers to approximate amounts when employers do not provide separate accounting [1] [2]. The IRS emphasized transition relief for 2025—employers are not required to separately report these amounts for that year, and workers can rely on pay records, employer statements or reasonable approximations to claim the deduction [1] [5].
2. What taxpayers may deduct and who qualifies
Under the One Big Beautiful Bill, individuals may deduct “qualified tips” and the portion of overtime pay that exceeds the regular rate (generally the half‑time premium of time‑and‑a‑half) for tax years 2025–2028, and the IRS guidance clarifies eligibility rules and examples for calculating those amounts [1] [2]. The deduction is available to both itemizing and non‑itemizing taxpayers for the applicable tax years, and the guidance contains worked examples—including bartenders and other tipped occupations—to show how to compute deductions without new boxes on W‑2s for 2025 [1] [6].
3. Practical calculation, forms and employer reporting expectations
For 2025, Forms W‑2, 1099‑NEC, 1099‑MISC and 1099‑K will not include new boxes, so employees should rely on pay stubs, employer statements or reasonable approximations and, when appropriate, Form 4137 reporting procedures for unreported tips; the IRS said it will update forms and instructions for 2026 to make separate reporting routine [2] [7]. Employers are encouraged to provide supplemental information voluntarily and to ready payroll systems for 2026 reporting, but the IRS provided a limited compliance grace period for 2025 and has indicated potential penalties for incomplete W‑2s beginning in 2026 if reporting obligations are not met [8] [9].
4. Limits, exclusions and open questions flagged by advisors
Third‑party tax advisers and firms note practical limits and exceptions in the IRS guidance: overtime paid under a collective‑bargaining agreement or overtime paid in excess of time‑and‑a‑half (e.g., double‑time) generally does not qualify for the overtime deduction, and definitions such as which employers’ businesses count as “specified service trades or businesses” for the tip deduction can be tricky to apply—IRS notices acknowledge those determinative issues and provide transition examples [10] [6]. Popular summaries also describe numerical caps touted in outreach—e.g., tip deduction potential up to $25,000 and overtime up to about $12,500 in some summaries—but those figures come from secondary explainers rather than the primary IRS text supplied here [11] [7].
5. State conformity and North Carolina’s posture (what is known and not known)
Reporting specific to North Carolina is limited in the provided coverage: local reporting notes that the federal changes create new deductions that North Carolina filers should be aware of this season, but no direct NCDOR technical bulletin or step‑by‑step state guidance was located in the supplied sources, and states generally retain discretion to conform to or diverge from the federal deductions—an issue that could materially affect state revenues and individual returns [3] [4]. Given that some states already mirror federal rules while others do not, taxpayers in North Carolina should watch for an explicit NCDOR announcement or consult the department’s website for state‑specific filing instructions; the supplied reporting does not include an NCDOR notice to cite [3].
6. What taxpayers and employers should do now
Taxpayers with tips or overtime should assemble pay stubs, employer communications and any internal statements to substantiate reasonable calculations for the 2025 deduction, follow IRS Notice 2025‑69 for examples, and expect updated forms and clearer employer reporting in the 2026 filing season [1] [2]. Employers should review payroll systems, consider voluntary supplemental statements to employees, and prepare for new W‑2 and 1099 reporting requirements for 2026 while noting the IRS’s limited 2025 relief followed by enforcement potential in later years [8] [9].