The One Big Beautiful Bill Act of 2025 gave employees new income tax deductions for qualified tips and qualified overtime pay. The deductions are claimed by the worker on a personal return, but they put new duties on employers: reporting these amounts separately on Form W-2 starting with 2026 pay, handling updated Forms W-4, and keeping records that back up the numbers. This page covers what a payroll department needs to know.
What is qualified overtime
Qualified overtime is only the premium part of overtime that the federal Fair Labor Standards Act (FLSA) requires. In time-and-a-half pay, it is the "half." If the employer pays more than the FLSA requires, such as double time, only the amount the FLSA required counts. The worker must be an FLSA overtime-eligible employee. An exempt employee does not have qualified overtime even if a contract or union agreement provides for overtime pay. The IRS notes, for example, that an employee who owns at least 20% of the business and actively manages it is generally treated as an exempt executive.
For most employees the IRS calculation is made each workweek: FLSA hours over 40, times one-half, times the FLSA regular rate. The regular rate generally includes all pay for the week, such as bonuses and commissions, except certain payments the FLSA excludes.
Example. A non-exempt employee earns $20 an hour with no other pay and works 45 hours in a week. The regular rate is $20. The employer pays 5 overtime hours at $30. Qualified overtime for the week is 5 x one-half x $20 = $50.
What are qualified tips
Qualified tips are voluntary cash tips, including card tips and tips received through a tip-sharing arrangement. Mandatory service charges are not tips unless the customer can disregard or change them. The worker must be in an occupation on the Treasury list of jobs that customarily and regularly receive tips. Treasury issued final regulations with that list in April 2026. It includes more than 70 occupations grouped in eight categories, such as beverage and food service, hospitality, personal services and transportation and delivery, each with a three-digit Treasury Tipped Occupation Code (TTOC).
What employers do in 2026
Keep withholding and paying payroll taxes as usual. Employers do not reduce withholding for either deduction on their own. An employee who expects the deduction can give you an updated Form W-4, which now has an entry in step 4(b) for it. When an employee submits one, you use it with the IRS withholding methods in Publication 15-T. See Form W-4 withholding.
Collect tip reports. Employees who receive $20 or more in tips in a month from one employer must report the total to the employer by the 10th of the next month. The employer uses the report to figure Social Security, Medicare and income tax withholding.
Report on Form W-2.
| Item | 2026 Form W-2 |
|---|---|
| Cash tips reported to the employer | Box 12, code TP |
| Occupation for those tips | Box 14b, up to two TTOC codes; use 000 for a nonqualifying occupation |
| Qualified overtime compensation | Box 12, code TT |
The TT figure is the total qualified overtime paid, which can be higher than the amount an employee is allowed to deduct. If you find an error in the TT amount, file Form W-2c and give a copy to the employee. A worker who is an employee under the FLSA but treated as a contractor for tax purposes would instead see the amounts on Form 1099-NEC or 1099-MISC, but the IRS describes that as rare.
Large food and beverage establishments where tipping is customary and that normally employ more than ten people have separate rules. They file Form 8027 each year, due the last day of February or March 31 if filed electronically, and may have to allocate tips when reported tips fall below 8% of gross receipts. Allocated tips are not subject to withholding, but they are shown on the W-2.
2025 was a transition year
For 2025, the IRS did not change the W-2 form and announced that employers would not be penalized for failing to separately report cash tips, tipped occupations or total qualified overtime, as long as the return or statement was otherwise correct and complete. Employers were still encouraged to give employees that information. Workers filing 2025 returns could estimate qualified tips and overtime using other records. That relief was limited to 2025.
Common mistakes
- Cutting withholding because an employee mentions the new deduction, without a new Form W-4.
- Counting all overtime pay as qualified, including double time or daily overtime that the FLSA does not require.
- Counting a mandatory service charge or an automatic gratuity as a tip.
- Using the wrong occupation code, or none, when reporting tips.
- Not tracking the regular rate, which makes the weekly overtime calculation unreliable.
- Treating exempt salaried workers as eligible.
How we can help
We set up payroll codes for tips and overtime, test that W-2 boxes 12 and 14b are populated correctly, and review whether your pay practices match the FLSA rules. For employees and owners who want to understand the deduction itself, see new deductions for tips and overtime. Learn more about our payroll services and restaurant and retail clients. This is general information, not advice for your particular facts.
Frequently asked questions
Are tips and overtime now tax free for payroll purposes?
No. They are still wages for income tax withholding, Social Security, Medicare and FUTA. The deductions reduce the employee's income tax when the employee files, and they can reduce withholding only through an updated Form W-4.
Where do I report qualified overtime on the 2026 W-2?
In box 12 with code TT. The amount is the total qualified overtime paid, not the deductible amount.
Do I need to report tipped occupation codes?
Yes, when you report cash tips with code TP, box 14b needs a Treasury Tipped Occupation Code, with up to two codes allowed. Use 000 for tips received in a nonqualifying occupation.
Does the deduction apply to independent contractors?
Self-employed people who receive qualified tips in a listed occupation can deduct them, limited to the net income of the business where the tips were earned. Overtime is different: it depends on being an FLSA overtime-eligible employee.
Official sources
- IRS: Updates to FAQs on the deduction for qualified overtime compensation (FS-2026-13)
- IRS: General Instructions for Forms W-2 and W-3 (2026)
- IRS: Final regulations listing tipped occupations
- IRS: Penalty relief for tax year 2025 tips and overtime reporting
- IRS: Topic no. 761, Tips withholding and reporting
This page is a plain-language summary. The official source controls if there is any difference.
General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.