If your business pays overtime or employs workers who earn tips, there’s a new payroll reporting requirement you shouldn’t wait until year-end to address.
Beginning with 2026 Forms W-2, employers must separately report qualified overtime compensation and qualified tips so eligible employees can potentially claim the federal deductions created under the One Big Beautiful Bill Act (OBBBA). While the deduction benefits employees, the responsibility for accurate reporting falls on employers.
For many businesses, the challenge won’t be paying overtime; it will be determining whether payroll systems, employee classifications, and reporting processes are prepared to meet the new requirements.
This Is More Than a Payroll Update
The new IRS guidance does not change overtime laws or require employers to pay additional wages. Instead, it changes how certain compensation must be tracked and reported.
Only the overtime premium required under the Fair Labor Standards Act (FLSA), the additional amount paid above an employee’s regular rate, qualifies for the deduction. Employees who are exempt from the FLSA overtime rules are not eligible, and overtime paid beyond the minimum required by the FLSA generally does not qualify for reporting.
Those distinctions make accurate reporting more complex than simply identifying employees who worked more than 40 hours.
Questions Every Employer Should Be Asking
Rather than waiting until Forms W-2 are prepared, now is a good time to evaluate whether your current payroll process supports the new reporting requirements.
Consider asking:
- Which of our employees are actually eligible for FLSA overtime?
- Can our payroll system identify the qualified overtime premium separately from total overtime wages?
- Does our payroll provider support the required reporting on 2026 Forms W-2?
- How will we document our calculations if questions arise?
- Do our payroll, HR, and finance teams understand the new reporting requirements?
These conversations can help identify potential issues while there is still time to address them.
Payroll Providers Handle Processing: Employers Remain Responsible
Many businesses rely on outside payroll providers, but that doesn’t eliminate the employer’s responsibility for accurate reporting.
Now is the time to confirm your provider can:
- Calculate only the qualified overtime premium required by the FLSA.
- Properly report qualified overtime and qualified tips on employee tax forms.
- Distinguish between overtime required by law and any additional premium compensation your business voluntarily provides.
- Produce reports that support your year-end reporting.
If your provider cannot answer these questions, additional planning may be necessary before year-end.
Small Errors Can Create Bigger Problems
These new reporting requirements touch several areas of your business, not just payroll.
An incorrect employee classification can affect overtime eligibility. Payroll system limitations can result in inaccurate reporting. Misunderstanding what qualifies for the deduction may create employee questions during tax season or require corrected information returns.
Taking time now to review your payroll processes can help reduce year-end administrative work and improve confidence that reporting is accurate.
How ARB Can Help
The new reporting requirements are another reminder that payroll compliance, tax reporting and employment rules often overlap.
ARB works with business owners to evaluate payroll reporting processes, review employee classifications, coordinate with payroll providers and address tax reporting questions before year-end. Identifying potential issues now can help reduce last-minute corrections and support a smoother reporting process when 2026 Forms W-2 are prepared.
If you’re unsure whether your payroll process is ready for these new reporting requirements, our team can help you evaluate your current approach and identify any adjustments that may be needed.
IRS Overtime Reporting Requirements FAQs
What changed from 2025 to 2026?
The deduction for qualified overtime compensation became available beginning with the 2025 tax year under the One Big Beautiful Bill Act (OBBBA). For 2025, employers generally were not required to separately report qualified overtime on Forms W-2 because the IRS provided transition relief while payroll systems adapted.
Beginning with 2026 Forms W-2, employers must separately report qualified overtime compensation in Box 12 using Code TT. This information helps eligible employees potentially claim the deduction on their federal income tax return.
Does all overtime qualify?
No.
Only the premium portion of overtime compensation required under the FLSA qualifies for the deduction. This is generally the additional “half” of time-and-a-half pay—not the employee’s entire overtime wage.
For example, if an employee earns $20 per hour and works five overtime hours, only the additional $10 per overtime hour qualifies—not the full $30 paid for each overtime hour.
Which employees qualify for the deduction?
Only employees who are eligible for overtime under the Fair Labor Standards Act (FLSA) may qualify. In general, this includes many nonexempt hourly employees.
Employees who are exempt from the FLSA overtime rules—such as many executive, administrative and professional employees—generally do not qualify because they are not entitled to overtime under federal law.
If you’re uncertain whether employees are properly classified, it’s a good time to review those classifications with your payroll provider or advisor.
How much can an employee deduct?
Eligible single taxpayers may deduct up to $12,500, or $25,000 for married taxpayers filing jointly.
These are maximum deduction amounts. Employers should continue to report the full amount of qualified overtime compensation paid, even if an employee’s allowable deduction is limited by the statutory cap or income phaseout.
Are there income limits?
Yes.
The deduction begins to phase out when modified adjusted gross income (MAGI) exceeds $150,000 for single taxpayers, or $300,000 for married taxpayers filing jointly.
Because these limitations are applied on the employee’s individual tax return, employers should report the full amount of qualified overtime compensation without attempting to calculate whether an employee qualifies for the full deduction.
Does this change how overtime is calculated?
No.
The IRS guidance does not change federal overtime laws or how employers calculate overtime pay.
Instead, it changes how qualified overtime compensation is identified and reported for federal tax purposes. Employers should continue to calculate overtime in accordance with the FLSA and applicable state wage laws.
My company pays double time. Does all of it qualify?
Generally, no.
Some employers voluntarily pay overtime at rates greater than those required by the FLSA, such as double time or enhanced holiday overtime. In these situations, only the amount minimally required under the FLSA is considered qualified overtime compensation for reporting purposes.
Any additional premium paid beyond the federal minimum generally does not qualify for the deduction.
What should I ask my payroll provider?
Before year-end, consider asking:
- Can our payroll system identify qualified overtime compensation separately from total overtime wages?
- Will qualified overtime be reported correctly in Box 12, Code TT?
- Can the system distinguish between required overtime premiums and additional premium pay?
- Are reports available to support our year-end reporting?
- Are there any system updates we need to complete before processing 2026 Forms W-2?
Addressing these questions now can help avoid corrections later.
Does my payroll software automatically handle this reporting?
Maybe, but don’t assume it does.
Many payroll providers are updating their systems to accommodate the new reporting requirements, but capabilities may vary depending on your provider and software version.
Employers should confirm that their payroll system can accurately calculate and report qualified overtime compensation before year-end rather than waiting until Forms W-2 are prepared.
Do overtime rules affect the federal reporting requirements?
While state-specific overtime laws determine when overtime is required, the federal deduction is instead determined by the FLSA. This may create differences in calculation of overtime, and subsequently what must be reported to the employee.
What happens if qualified overtime is reported incorrectly?
If an employer discovers an error after issuing a Form W-2, the employer generally must file a Form W-2c (Corrected Wage and Tax Statement) and provide the corrected form to the employee.
Incorrect reporting may delay an employee’s ability to claim the deduction and could expose employers to information reporting penalties, although reduced penalties may apply when corrections are made promptly.
How can ARB help my business prepare?
These new reporting requirements bring together payroll administration, employee classification, tax reporting and compliance. ARB can help your business:
- Review employee classifications.
- Evaluate payroll reporting processes.
- Coordinate with your payroll provider.
- Answer questions about the federal reporting requirements. Identify potential issues before year-end reporting begins.
Preparing now can help reduce administrative burdens during W-2 season and improve confidence that your payroll reporting complies with the latest IRS guidance.
Nicholas K. Lagoditz is a Tax Manager with ARB who provides tax services to construction, manufacturing, and ESOP-owned entities. Working closely with clients, he helps to improve their financial reporting and support their business goals.
