Somewhere in your payroll system right now there's a number nobody is tracking. It's the premium half of every overtime hour your team has worked since January. In January 2027, the IRS expects that number to show up on a W-2.
2025 was a grace period. The IRS gave employers penalty relief and made reporting essentially optional while everyone figured out what the One Big Beautiful Bill Act actually required. That grace period is over. Tax year 2026 is the first year this is mandatory, and the wages you're processing today are the wages you'll have to report. If you haven't looked at this yet, you have about four months, and fixing it in September is a very different project than fixing it in December.
Two new codes appear in Box 12 of the 2026 Form W-2. Code TT is for qualified overtime compensation. Code TP is for qualified tips. There's also a new Box 14b that captures the Treasury Tipped Occupation Code, which identifies whether an employee works in an occupation that customarily receives tips.
That sounds like a payroll vendor problem, and part of it is. But the codes are only as good as the data behind them, and the data behind them is where this gets interesting.
Code TT is not your total overtime pay. It's the premium portion only.
If someone earns $20 an hour and gets time and a half, their overtime rate is $30. Only the extra $10 is qualified overtime. The first $20 is just regular wages. So for an employee who worked 200 overtime hours this year, you're not reporting $6,000. You're reporting $2,000.
Most payroll systems store the blended overtime rate and the hours worked. They don't store the premium as a separate, reportable field, because until now nobody needed it that way. That's the gap to check first.
Only overtime required by Section 7 of the Fair Labor Standards Act counts. That's the standard over-40-hours-in-a-workweek premium, and nothing else.
It does not include weekend or holiday premiums, shift differentials, double time under a union contract, daily overtime required by state law but not federal law, or anything paid to an exempt employee. If your policy or your collective bargaining agreement pays richer than the FLSA requires, only the FLSA-required piece is reportable.
Tips have their own set of rules. They have to be voluntary, paid in cash, card, check, or electronic transfer, and earned in an occupation that customarily and regularly received tips. Mandatory service charges don't qualify, and neither do tips in specified service trades or businesses. That's a real distinction for any restaurant that adds automatic gratuity to large parties.
This is the part to put in front of your managers now, not in January.
These provisions create deductions employees claim on their tax return, available for tax years 2025 through 2028. The overtime deduction is capped at $12,500 ($25,000 for joint filers) and the tip deduction at $25,000, and both phase out starting at $150,000 of modified adjusted gross income ($300,000 joint).
Withholding continues. FICA continues. Social Security and Medicare are still coming out of every overtime hour and every reported tip. A lot of employees heard "no tax on overtime" and reasonably assumed their check would grow. It didn't, and it won't. The person who hears about that is a shift supervisor who has no idea what to say, which is how a tax provision turns into a trust problem.
A short, plain-language explainer in October costs you almost nothing. A year of confused employees costs you a lot more.
Federal reporting is the same everywhere. State treatment is not.
Michigan's version of the deduction applies to income earned in 2026, so it shows up on returns filed in early 2027. Colorado decoupled from the overtime deduction. Maine's governor directed the state not to conform to either one. Washington, D.C. passed legislation reinforcing its decoupling. Other states conform automatically because of how their tax codes are structured, without their legislatures voting on it at all.
If you employ people in more than one state, and most growing companies now do without ever really deciding to, the number in Box 12 is identical while the tax outcome behind it is not. Your employees will ask about that difference. It helps to know the answer before they do.
This isn't a tax problem. It's a data problem wearing a tax problem's clothes. The deduction belongs to your employees, but the obligation to produce clean, correctly classified wage data belongs to you, and that data has been accumulating all year whether anyone was watching it or not.
Most of the employers who get burned by this won't have done anything wrong on purpose. They'll get to December, ask payroll for a number, and find out it was never being kept.
If you're not sure where your organization stands, that's a conversation worth having now, while there's still time to fix it quietly.