The individual deductions for qualified tips and qualified overtime only work if employers report the right numbers. Section 225(a) allows the overtime deduction only for amounts included on the employee's statement, and section 224(a) does the same for tips (with a Form 4137 alternative). That puts employer clients in the middle. The 2025 transition year is closed. For 2026, the new Form W-2 boxes are mandatory, and Forms W-2 for 2026 go out in early 2027. Payroll setup must be right before year end.
What does the statute require of employers?
Public Law 119-21 added two items to the list of amounts an employer must show on the Form W-2 under section 6051(a):
- Paragraph (18): the total amount of cash tips reported by the employee under section 6053(a) and the employee's occupation as described in section 224(d)(1).
- Paragraph (19): the total amount of qualified overtime compensation as defined in section 225(c).
Parallel changes to sections 6041, 6041A and 6050W require payors and third party settlement organizations to report tips designated as cash tips, with the recipient's occupation, on Forms 1099, and require a separate accounting of qualified overtime on the 1099 for a worker who is not treated as an employee. Both sets of amendments apply to taxable years beginning after December 31, 2024.
What relief applied for 2025?
Notice 2025-62 (released November 5, 2025, IR-2025-110) states that the IRS will not impose penalties under section 6721 (failure to file correct information returns) or section 6722 (failure to furnish correct payee statements) for 2025 for failing to report separately:
- cash tips or the tip recipient's occupation, on Forms W-2 and the affected Forms 1099; and
- qualified overtime compensation.
The relief applies only to 2025 and only if the return or statement is otherwise complete and correct. The IRS also confirmed that 2025 Forms W-2 and 1099 would not be updated for these provisions. Employers were encouraged, not required, to give employees the figures through an online portal, an additional written statement, or for overtime, box 14 of Form W-2.
Notice 2025-69 then let employees use those voluntary figures, or their own estimates, on 2025 returns. That flexibility is gone for 2026, and FS-2026-13 says no relief is available for overtime after 2025.
What changed on the 2026 Form W-2?
The 2026 General Instructions for Forms W-2 and W-3 list these changes:
| Item | 2026 reporting |
|---|---|
| Cash tips reported to the employer | Box 12, code TP |
| Treasury Tipped Occupation Code(s) | New box 14b, up to two codes |
| Former box 14 "Other" | Now box 14a |
| Qualified overtime compensation | Box 12, code TT |
Box 14b rules: enter up to two codes based on the occupations in which tips were received. If tips came from more than two occupations, enter codes for any two. If any tips were received in a nonqualifying occupation, "000" must be one of the codes. Codes come from IRS.gov/TippedOccupations, which reflects the final regulations under section 224 (TD 10044) and their three-digit Treasury Tipped Occupation Code system.
For code TT, the instructions say only the "half" portion of time-and-a-half is reported. FS-2026-13 adds that the employer reports the total qualified overtime paid, even when it exceeds what the employee can deduct; its example is $30,000 reported in code TT despite the $12,500 cap.
For workers on Forms 1099, FS-2026-13 points to Form 1099-NEC box 1d and Form 1099-MISC box 14 for qualified overtime, and says this situation is rare: it arises only where the worker is an FLSA employee but an independent contractor for tax purposes.
How should payroll calculate qualified overtime?
FS-2026-13 gives the general workweek formula for FLSA overtime-eligible employees:
FLSA hours worked over 40 in the workweek × one-half × the employee's FLSA regular rate = qualified overtime compensation for the workweek.
Points to build into the payroll configuration:
- Regular rate, not base rate. The FLSA regular rate includes all remuneration for employment except statutory exclusions under 29 USC 207(e). A nondiscretionary bonus that raises the regular rate also raises the premium.
- Premium above FLSA. Double time, daily overtime, weekend premiums or state law overtime are not qualified beyond the amount minimally required by 29 USC 207. Payroll needs a separate earnings code (or a calculated field) for the FLSA premium, distinct from the total overtime earnings code.
- Alternative FLSA methods. Hospitals using the 8-and-80 system, public safety work periods under section 207(k), and public sector compensatory time under section 207(o) use the premium actually paid under that provision. For compensatory time, FS-2026-13 says qualified overtime is paid when the comp time is used and paid as wages, or cashed out at termination, not when it is earned.
- Exempt employees. No code TT for FLSA-exempt employees, even if company policy or a union contract pays them overtime. The FAQ treats a 20 percent owner actively engaged in management as an exempt executive.
- Timing. Qualified overtime is "paid" under the same principles that determine when wages are paid for withholding purposes.
What about tips in payroll?
Employees must report tips to the employer by the tenth day of the month after they are received, under section 6053(a) (Notice 2025-69 restates the rule). Code TP is the total cash tips the employee reported. Payroll and point-of-sale data should feed the same tip fields, and each tipped job title needs a TTOC mapping, including a "000" mapping for roles that are not on the list. Mandatory service charges stay out of tips: the IRS release on the final regulations says an automatic charge the customer cannot disregard or modify is not a qualified tip. Restaurants and salons that relabel service charges as gratuities should fix that before year end. For audit-side testing of tip reporting, see the restaurant audit guide.
Section 70201 also extended the section 45B credit for employer social security tax on tips to tips received for barbering and hair care, nail care, esthetics, and body and spa treatments, where tipping is customary. Salon and spa employers should be reviewed for the credit.
Withholding and payroll taxes do not change
The deductions are income tax deductions only. The 2026 W-2 instructions say tips and overtime remain generally subject to income tax withholding and to both shares of social security and Medicare tax. FS-2026-13 says an employer may not reduce withholding for the overtime deduction unless the employee furnishes an updated Form W-4, which accounts for it in step 4(b). Deposits and Form 941 work as before; see payroll tax deposit schedules.
Errors and corrections
FS-2026-13 says an employer that discovers an error in code TT must file Form W-2c with the Social Security Administration and furnish it to the employee as soon as possible, and that incorrect forms can draw section 6721 and 6722 penalties. An employee whose code TT is understated cannot fix it with Form 4852, so W-2c requests will come in during filing season. Build a process to handle them quickly. Deadlines and correction rules are in W-2 and 1099 filing deadlines and corrections.
Year-end checklist for employer clients
- Map each tipped job to a TTOC, with "000" for nonqualifying roles.
- Add or confirm an earnings code that isolates the FLSA overtime premium, separate from straight-time overtime and non-FLSA premiums.
- Flag FLSA-exempt employees and 20 percent owner-managers so no code TT is produced.
- Run a test W-2 with boxes 12 (TP, TT) and 14b populated; reconcile to payroll registers.
- Confirm service charges are not coded as tips.
- Set up a W-2c workflow for code TT disputes.
- Review section 45B eligibility for beauty service employers.
Employees will rely on these numbers for the tips deduction and the overtime deduction.
CORAA prepares ready-to-review audit files for US CPA firms; see /us.
Sources
- U.S. Government Publishing Office, Public Law 119-21 (sections 70201 and 70202): https://www.govinfo.gov/content/pkg/PLAW-119publ21/html/PLAW-119publ21.htm
- IRS, Notice 2025-62, Relief from Certain Penalties Related to Information Reporting Required in Connection with No Tax on Tips and Overtime: https://www.irs.gov/pub/irs-drop/n-25-62.pdf
- IRS, Treasury, IRS provide penalty relief for tax year 2025 for information reporting on tips and overtime (IR-2025-110): https://www.irs.gov/newsroom/treasury-irs-provide-penalty-relief-for-tax-year-2025-for-information-reporting-on-tips-and-overtime-under-the-one-big-beautiful-bill
- IRS, 2026 General Instructions for Forms W-2 and W-3: https://www.irs.gov/pub/irs-pdf/iw2w3.pdf
- IRS, FS-2026-13, Updates to questions and answers about the new deduction for qualified overtime compensation: https://www.irs.gov/pub/taxpros/fs-2026-13.pdf
- IRS, Notice 2025-69, Guidance for Individual Taxpayers who received Qualified Tips or Qualified Overtime Compensation in 2025: https://www.irs.gov/pub/irs-drop/n-25-69.pdf
- IRS, Treasury, IRS issue final regulations listing occupations where workers customarily and regularly receive tips (IR-2026-49): https://www.irs.gov/newsroom/treasury-irs-issue-final-regulations-listing-occupations-where-workers-customarily-and-regularly-receive-tips-under-the-one-big-beautiful-bill
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