The New Tips and Overtime Deductions and 1099s

Last week, we looked at the 2026 drafts of Forms 1099-NEC and 1099-MISC. These new boxes refer to qualifying tips and qualifying overtime. The One Big Beautiful Bill (OBBB), signed into law in 2025, creates a new deduction for these items. The deduction is taken on personal tax returns by the worker who received qualifying tips and overtime.

There’s more to it than that, but it will suffice for this discussion.

Let’s look deeper at the tips and overtime deduction, and when you might need to use a 1099 to report them.

Overtime

Let’s start with overtime. OBBB defines qualifying overtime as overtime paid under Section 7 of the Fair Labor Standards Act of 1938. This is where the requirement to pay at least time-and-a-half to hourly workers if they work more than 40 hours in a workweek.[1]

FLSA covers employees, not contractors. Only overtime paid under this provision needs to be separately reported. Why would 1099s have a new box for overtime, if you’ll never be paying qualifying overtime to a contractor?

DOL versus IRS

To understand this, we need to look at the rules relating to worker classification. Worker classification is the process by which you determine if the worker you are paying is an employee or a contractor.

Both the IRS and the Department of Labor take an interest in how you classify workers in your organization. The DOL uses a test called the “economic realities test,” while the IRS uses a test called the three-factor test. This is where this issue of tips and overtime on a 1099 might happen.

A worker could be considered an employee under the DOL’s tests but a contractor under IRS tests. The DOL oversees FLSA. The IRS oversees tax law.

So, you could have a worker who is an employee in the eyes of the DOL. Because they’re an employee for the DOL, FLSA applies. If this worker is classified as a contractor by the IRS, you’d be reporting their overtime on a 1099, not a W-2.

This would be a highly unusual circumstance. It’s not “hypothetical,” because it actually could (and once in a great while, does) happen.

Your author has read about this situation of dual-classification, but has never seen it himself. If a reader has ever seen it or experienced it, please email jason@dinesenmedia.com – I’d love to hear about it!

Tips

Qualifying tips are:

1.     Paid voluntarily by the customer, and

2.     Paid in cash (or charged to a card), and

3.     Paid to a worker who is working in an industry where tipping is customary.

Form 1099 reporting of a tip could involve:

• Our dual-classification issue, with a worker who is an employee for the DOL and a contractor for the IRS, as discussed in the prior section, or
• Your organization pays a tip to an independent contractor who works in an industry where tipping is customary.

The second bullet point is the most likely spot where you’d be reporting tips.

Treasury Tipped Occupation Code

Qualifying tips must be paid to a worker in an industry where tipping is customary. The Treasury Department has published a list of such industries. They identified 68 industries, and you can find the list in the proposed regulations.

Many times in examples, we simply say “contract labor” as an all-encompassing term. When giving examples here, though, we need to be specific. A contractor doing I/T work, for example, is not on the list, nor is general labor.

 For this example, we have chosen the following:

• Private Event and Portrait Photographers for the “Treasury Tipped Occupation Code.”
• This is TTOC 503 under the main category of “Recreation and Instruction.”
• The Related Standard Occupational Classification (SOC) is27-4021.

What does all of this mean? Let’s explain with an example.

Your organization holds its annual company retreat. As part of this, you pay $3,000 to Great Photography Adventures, LLC to document every moment of the retreat. The payment is made by an ACH transaction. That Guy owns Great Photography Adventures, LLC as a disregarded entity, so this is a sole proprietor, with reporting happening to That Guy.

At the end of the day, you hand $200 in cash to That Guy as a tip.

Reporting will be:

• The 1099-NEC is issued to That Guy under his TIN.
• Box 1a will be for $3,200 ($3,000 fee plus $200 tip).
• Box 1b will show $200 (reflecting the tip).
• Box 1c will show 27-4021 (the occupation code).

There are many ways complications can set in. Let’s look at one way – you pay the $3,000 fee with your company credit card but hand cash to That Guy for the tip. The regulations say you don’t issue a 1099 at all if you use your credit card, so you won’t report the $3,000 payment at all. You’re left with a $200 tip which is theoretically reportable but which is well below the $2,000 filing threshold. You aren’t required to issue a form, but you could. If you chose to, the reporting would be:

• The 1099-NEC is issued to That Guy under his TIN.
• Box 1a will be for $200.
• Box 1b will show $200 (reflecting the tip).
• Box 1c will show 27-4021 (the occupation code).

Why is 1a only $200? Because the $3,000 portion of your payment was made with a credit card, and the regulations explicitly say not to issue a 1099 to report payments made with a card. This is not an optional thing (such as issuing a form even when payments are less than the threshold, or sending a 1099 to a corporation).

 Another twist: you pay both the base fee and the tip using a credit card. You are not required to report ANYTHING. Instead it will be up to the merchant processor to report the tip portion properly on a Form 1099-K.

[1]Workers in certain industries such as law enforcement can have different measurement periods (other than 40 hours workweeks) for determining overtime. The bottom line is, if overtime is paid under Section 7 of FLSA, it is considered “qualifying.”