No Tax on Overtime: What Employers Must Track for 2026 W-2s

From 2026, employers must report each worker's qualified overtime on Form W-2, in box 12 with code TT. Qualified overtime is only the premium half of the time-and-a-half that federal law requires. Your employees use that number to claim a new deduction. Your job is to calculate it correctly every pay period.

I have run payroll changeovers at three small companies. The ones that went badly all had the same cause. Somebody assumed the software would handle a new rule, and nobody checked until the year-end forms came out wrong.

This guide is for owners and office managers at businesses with 5 to 50 people who pay some staff by the hour. It explains what the new rule asks of you, how to work out the number, and what to check with your payroll provider before December. The facts here are as of October 2026. This is not legal or tax advice, so take anything unusual to your accountant.

What Is Qualified Overtime, in Plain Terms?

Qualified overtime is the extra half you pay on top of the regular rate when federal law requires overtime. If someone earns $20 an hour and works an overtime hour at $30, only $10 is qualified overtime. The $20 base part is ordinary wages. Overtime paid by choice or under state rules alone does not count.

The IRS spells this out in its questions and answers on the overtime deduction. It says the half portion of time-and-a-half is the qualified part. Employees can deduct up to $12,500 a year, or $25,000 on a joint return. The deduction phases out above $150,000 of income, or $300,000 for joint filers.

The deduction runs for tax years 2025 through 2028. For 2025, employers did not have to report the amount separately. For 2026 onward, they do.

Which Overtime Counts and Which Does Not

The federal rule behind all this is section 7 of the Fair Labor Standards Act (FLSA). The Department of Labor's fact sheet on FLSA overtime pay sets the basics. Non-exempt employees get at least time and one-half for hours over 40 in a workweek.

That means plenty of overtime you pay falls outside the deduction. The IRS lists several kinds that fall outside the deduction. Here is how they compare.

The state-law row catches a lot of small employers. If your state requires overtime that federal law does not, you still pay it. You just leave it out of the code TT figure.

How to Work Out the Code TT Number

The calculation is simple once you separate the premium from the base pay. The hard part is getting the regular rate right in weeks with bonuses or commissions. Follow these steps for each non-exempt employee.

Here is a worked example. A warehouse packer earns $20 an hour and works 46 hours in a week. Six hours are overtime. She earns $180 for those hours at $30 each, and the qualified part is 6 times $10, or $60.

Now stretch that across a busy season. Say she averages four overtime hours a week for 50 weeks. That is 200 overtime hours, and 200 times $10 is $2,000 of qualified overtime for her W-2.

The Labor Department fact sheet also has a salaried example. An employee paid $405 for a 45-hour week has a regular rate of $9. The five overtime hours earn an extra half rate of $4.50 each, so $22.50 is owed on top of the salary. Under the new rule, that $22.50 is the amount that counts.

What Changes on the 2026 W-2

The form itself gains two new box 12 codes. The IRS General Instructions for Forms W-2 and W-3 say code TT reports total qualified overtime compensation. A second code, TP, reports cash tips reported to the employer, for the matching tip deduction.

The instructions also set the filing date. Your 2026 Forms W-2 are due to the Social Security Administration by February 1, 2027. Box 12 only fits four items on each copy. An employee with several box 12 entries may need a second W-2.

Note what does not change. Overtime is still subject to federal income tax withholding. It is still subject to both the employer and employee shares of Social Security and Medicare. The IRS also points out that code TT is the total paid, which may differ from what the employee can actually deduct. You report the full amount and let them apply the limits.

Contractors are a separate matter. A freelancer you pay by invoice is not owed FLSA overtime, so there is no code TT for them. If you use contractors during busy periods, our explainer on the new $2,000 1099 threshold for contractor payments covers what you do need to file for them.

Questions to Ask Your Payroll Provider Before December

Most small businesses run payroll through a service or software package. That provider will populate the W-2. You still sign off on it, so it is worth a short call this quarter.

These are the questions I would ask:

If the answer to the third question is no, you have work to do. You may need a separate earnings code for state-only overtime, set up before the next pay run. Our tools section looks at payroll and HR software for small teams if your current system cannot cope.

Time Records That Back Up the Number

A code TT figure is only as good as the timesheets behind it. If an employee or the IRS ever asks how you reached it, you want to show the hours week by week. That matters more now that the number feeds straight into someone's tax return.

Two federal rules shape those records. The Department of Labor says overtime earned in a workweek must be paid on the regular payday for that pay period. It also says the overtime requirement cannot be waived by agreement between you and the employee. So a handshake deal to swap overtime for time off later does not remove the premium you owe.

I have watched small teams lose track of hours in two places. One is paper timesheets that someone retypes on Friday. The other is staff who clock out and then answer customer messages from home. Both create overtime that never reaches payroll. A simple app-based time clock, with a rule that after-hours work gets logged, fixes most of it.

Common Mistakes With the New Overtime Reporting

New rules attract the same handful of errors. In my experience, small teams usually make one of these four.

The first is reporting the whole overtime wage. If the packer above earns $180 for six overtime hours, the W-2 should show $60, not $180. Reporting the full amount inflates the employee's deduction and leaves them exposed if the IRS questions it.

The second is including exempt staff. Paying a salaried supervisor a flat bonus for a heavy month is fine. It does not belong in code TT, because the FLSA did not require it.

The third is getting the regular rate wrong. The DOL fact sheet says the regular rate includes all pay for employment except specific exclusions. A shift premium or a production bonus that staff expect usually belongs in it, and that raises the half-time premium too.

The fourth is forgetting to tell employees. Staff will hear about no tax on overtime and assume their paychecks will change. A short note explaining that the benefit arrives when they file their return saves a lot of confused questions in January.

Getting Qualified Overtime Right This Year

The new rule asks one thing of employers. Track the premium half of every FLSA overtime hour and report the 2026 total in box 12, code TT. Withholding stays the same, and the employee claims the deduction on their own return.

Your next step is to pull a year-to-date overtime report now and check it against the steps above. Fix any earnings codes before the holiday rush adds more hours. If your staff work under a union contract or in a state with its own overtime rules, ask your accountant to review the setup.