Here’s what HIVE AI had to say about “How have audit guidelines changed for tip/overtime claims?”:
What changed in audit/exam treatment for tip and overtime claims (2025 returns filed in 2026, and going into 2026+)
1) New “no tax on tips” and “no tax on overtime” deductions created a new exam area
For tax year 2025 (returns filed during the 2026 filing season), eligible workers can claim new deductions for qualified tips and qualified overtime compensation under the One, Big, Beautiful Bill Act, and the IRS issued guidance explaining how taxpayers compute those deductions. 3 4
Practically, this means IRS income-tax examinations now have to verify:
- Whether the taxpayer is eligible for the deduction, and
- Whether the amount claimed is computed correctly under the IRS-approved methods (especially where Forms W-2/1099 did not separately report the amounts for 2025). 4
2) For 2025 only, the IRS shifted “substantiation/computation” more onto taxpayer records (because W-2/1099s didn’t change yet)
For tax year 2025, the IRS explicitly stated there were no changes to 2025 Forms W-2 / 1099-NEC / 1099-MISC / 1099-K to separately account for cash tips or qualified overtime compensation, and the IRS issued methods for individuals to compute the deductible amount without a separate employer accounting. 4 1
Audit implication: for 2025 claims, IRS reviews are more likely to rely on the taxpayer’s own support (for example, paystubs/payroll statements showing an “overtime premium,” or tip logs where forms don’t separately identify tips). 1 3
3) New line mechanics for claiming the deductions (Schedule 1-A for 2025) changed what the IRS will verify
The IRS released a new Schedule 1-A for tax year 2025 and related instructions explaining how taxpayers will claim and compute these deductions. 5
Audit implication: IRS “math error” and correspondence workflows can focus on whether the Schedule 1-A computation method was followed and whether the amount claimed fits within the statutory limits/phaseouts described in the IRS instructions/guidance. 5
4) Starting with 2026 (returns filed in 2027), reporting is expected to improve, which changes audit selection/matching
IRS guidance indicates that for tax years 2026 and later, employers/other payers are required to separately report qualified overtime compensation, and forms will be updated to support that reporting. 6
Audit implication: beginning with 2026, the IRS can more directly match a taxpayer’s claimed overtime deduction to third-party reporting, shifting audits away from “reconstruct the amount from payroll records” and toward “does the claimed amount match the separately reported amount, and is the taxpayer eligible.” 6
5) Separate change: employment tax tip exam procedures were updated in IRM Part 4 (effective May 16, 2025)
Separately from the new income-tax deductions, IRS Examination issued IRM procedural updates (effective 05/16/2025) revising IRM 4.23.7 (employment tax on tip income) and IRM 4.23.10 (report writing guide for employment tax examinations). 2
These IRM updates relate to how the IRS conducts and documents employer-side employment tax tip examinations (not just how an individual claims the new tip deduction on Form 1040). 2
Sources
1 – IRS Newsroom – IR-2025-114
2 – IRS.gov – Part 4 – Examining process
3 – Treasury, IRS provide guidance for individuals who received tips or overtime during tax year 2025
4 – Internal Revenue Bulletin: 2025-50
5 – IRS published schedule taxpayers will use to claim deductions on no tax on tips, no tax on overtime, no tax on car loans, no tax on seniors
6 – Questions and answers about the new deduction for qualified overtime compensation
Try Your AI Tax Assistant for Free!
Ready to transform your practice with agentic AI in tax? See firsthand how our cutting-edge AI tax tools can revolutionize your approach to tax research and planning.