The New W-2 Reporting Requirement Most Employers Are Underestimating

Beginning with tax year 2026, employers must separately report qualified overtime compensation on Form W-2 in box 12 using code TT, and an employee can generally only claim the overtime deduction for the amount their employer actually reported there. That second half is what makes this a payroll problem rather than a tax-season problem. If the number is missing or understated on the W-2, the employee cannot make up the difference from their own records, and the transition relief that covered tax year 2025 no longer applies.

What the deduction actually covers

The One, Big, Beautiful Bill Act created an income tax deduction for qualified overtime compensation, available to certain individuals paid overtime required under section 7 of the Fair Labor Standards Act. According to the IRS fact sheet updating its guidance on the deduction, the deduction is available whether the individual itemizes or takes the standard deduction, and overtime compensation not required by the FLSA is not eligible.

The deduction is capped at $12,500 of qualified overtime compensation per individual return, or $25,000 on a joint return, and is reduced where modified adjusted gross income exceeds $150,000, or $300,000 for joint filers.

The critical detail for payroll is what “qualified” means. It is the portion of FLSA-required overtime that exceeds the employee’s regular rate, which for standard time and a half is the half. The IRS states the calculation directly: FLSA hours worked over 40 in a workweek, multiplied by one-half, multiplied by the employee’s FLSA regular rate of pay. Where an employer pays more than the FLSA requires, only the amount minimally necessary to satisfy the statute counts. The fact sheet gives an example of a worker paid double time who received $400 in overtime pay for ten overtime hours, of which only $100 was qualified overtime compensation, because that was the premium the FLSA actually required.

The W-2 reporting burden lands on payroll, and it is not optional

The reporting obligation is what most employers are underestimating. The IRS confirms that starting in tax year 2026, employers must separately report qualified overtime compensation on Form W-2 in box 12 with code TT, and that the amount reported is the total qualified overtime compensation paid, which may exceed what the employee can ultimately deduct because of the annual limits and phaseouts. The fact sheet illustrates this with an employer who paid $30,000 in qualified overtime during 2026 and must report the full $30,000 in box 12, code TT, even though the maximum deduction is far lower.

For industries where overtime is routine and pay is built from multiple rates, isolating that figure is not trivial. Contractor-facing explainers on the qualified overtime tax deduction make the same practical point that the IRS guidance implies: the deduction is calculated per workweek against each worker’s regular rate, so a payroll system has to know when each person started and stopped, on which day, and at what rate. Many payroll configurations were built to produce a gross overtime figure rather than to separate the premium from the straight-time portion, and that configuration gap is the thing to find in the fourth quarter rather than in January.

Understated amounts cannot be fixed by the employee’s W-2

The consequence of getting the number wrong is asymmetric, and it falls on the worker. The IRS is explicit that for tax years after 2025, employees may not consider any amount of qualified overtime compensation beyond what appears on Form W-2 in box 12, code TT.

If an employer understates the amount, the employee must request a corrected Form W-2c in order to claim the larger figure. If the employer is unwilling or unable to furnish that correction, the employee is limited to the reported amount even where they were in fact paid more. The agency also closes the obvious workaround: Form 4852, the substitute for a W-2, cannot be used to claim additional qualified overtime, because the statute requires the amount to be furnished on the W-2 itself.

Overstatement is treated separately and does not help anyone. Where an employer reports more than was actually paid, the employee may only consider the actual amount.

Correction obligations run in both directions. The guidance states that an employer discovering an error in box 12, code TT must file Form W-2c with the Social Security Administration and furnish it to the employee as soon as possible, and notes that filing or furnishing an incorrect Form W-2 may expose the employer to information reporting penalties, with reduced penalties available for timely corrections. The IRS maintains a reference page for Form W-2c covering its use for correcting previously filed statements.

Withholding does not change, and employees should be told so

A predictable point of friction is the gap between the deduction and the paycheck. The IRS is clear that overtime compensation, including qualified overtime compensation, remains subject to federal income tax withholding, and that an employer may not reduce withholding to account for the deduction unless the employee furnishes an updated and valid Form W-4 reflecting the expected deduction.

The 2026 Form W-4 was updated so employees can account for the deduction in step 4(b), and the IRS notes that its withholding estimator was updated for the same purpose. Employers that expect questions from crews in January are better off explaining this in advance than fielding it individually: the benefit arrives when the worker files, not as a larger weekly check.

The deduction also does not change the employer’s own cost. Overtime compensation is generally not excluded from wages for employment tax purposes, including Social Security and federal unemployment taxes.

Two W-2 eligibility questions worth resolving early

Two determinations in the guidance are easy to get wrong at a small or mid-sized company.

The first is whether an employee is FLSA overtime-eligible at all. The IRS notes that an individual who is ineligible for overtime under the FLSA does not receive qualified overtime compensation regardless of other laws or arrangements, including a collective bargaining agreement providing for overtime pay. State daily-overtime rules and contractual premiums that go beyond the federal requirement fall outside the deduction.

The second concerns owners. The guidance states that an employee who owns at least a bona fide 20 percent equity interest in the enterprise and is actively engaged in its management is considered a bona fide executive exempt from the FLSA’s overtime requirement, and therefore overtime-ineligible. Companies where a working owner takes hourly pay should resolve that question before the W-2 is produced.

A short pre-year-end checklist

• Confirm the payroll system can isolate the premium. The reportable figure is the FLSA-required amount above the regular rate, calculated per workweek, not a gross overtime total.
• Reconcile the regular rate definition. The regular rate includes all remuneration for employment except statutory exclusions, so bonuses and certain premiums may change it.
• Identify which employees are FLSA overtime-eligible. Exemption status drives eligibility, and other overtime arrangements do not substitute.
• Decide who owns corrections. Errors require a W-2c, and the timing of that correction affects both the employee’s ability to claim the deduction and the employer’s penalty exposure.
• Draft the employee explanation now. Withholding does not change, and the first payroll of 2026 is when people will ask why.

Read Next

A few related pieces worth your time:

• How to Measure Search Visibility More Effectively
• The Operating Model Behind Modern IT: What “Managed” Actually Means
• What to Look for in an Accountant for Your IT MSP

The wider point

The IRS announced these updates in a news release accompanying the revised FAQs, and the shape of the change is worth reading carefully. A tax benefit that belongs to the employee has been made contingent on the accuracy of an employer’s payroll reporting, with a correction path that depends on the employer’s cooperation. That is a meaningful shift in where the burden sits.

For employers whose timekeeping produces exact daily hours by workweek, the new box is a configuration task. For employers whose hours arrive rounded, batched, or reconstructed, it is a reconciliation problem that arrives with a January deadline and a workforce that has read about the deduction. Guidance of this kind is general information rather than tax advice, and specifics are worth confirming with a qualified tax professional before year-end.