New overtime reporting rules reshape 2026 payroll

The IRS has removed a major implementation ambiguity for employers paying overtime in 2026: qualified overtime compensation must be separately identified on worker statements, regardless of whether the employee will be entitled to deduct the full amount. The clarification gives payroll departments a narrow definition to track and a new correction obligation to manage before 2027 filing season.

In an update added August 6, 2026, the IRS said employers must report qualified overtime compensation paid beginning in 2026 on Form W-2, box 12, using code TT. The agency’s 2026 Form W-2 instructions likewise identify code TT as the reporting mechanism for total qualified overtime compensation.

The rule follows the July 4, 2025 enactment of the One, Big, Beautiful Bill Act, which created a temporary individual deduction for tax years 2025 through 2028. The IRS previously gave employers reporting relief for 2025. That relief does not carry forward: for 2026 and later years, separate reporting is required.

The amount reported under code TT is not necessarily an employee’s deductible amount. The IRS defines qualified overtime as compensation required under section 7 of the Fair Labor Standards Act that exceeds the employee’s regular rate. For a typical employee paid time and a half, the qualifying amount is generally the additional half-time premium, not the full overtime paycheck.

The agency’s August guidance says employers generally determine the amount by workweek: FLSA hours over 40, multiplied by one-half, multiplied by the employee’s FLSA regular rate. That calculation can become more complicated when workers receive bonuses, commissions, multiple pay rates, or other compensation affecting the regular-rate analysis. Payroll teams should therefore ensure that timekeeping and wage calculations use the same underlying data.

Separately identifying the premium does not convert it into tax-free wages. The IRS’s 2026 W-2 and W-3 instructions state that overtime compensation is generally subject to federal income-tax withholding and the employer and employee shares of Social Security and Medicare taxes. The new rule is principally an information-reporting requirement supporting an employee income-tax deduction.

For 2026, the deduction is capped at $12,500 for an individual return and $25,000 for a joint return, with phaseouts beginning at modified adjusted gross income of $150,000 and $300,000, respectively, according to the IRS. Those limits affect the employee’s return; they do not reduce the amount the employer must place in box 12, code TT.

The IRS says an employer that discovers an error in code TT must file Form W-2c with the SSA and furnish the correction to the employee as soon as possible. Incorrect information returns or payee statements can trigger penalties under sections 6721 and 6722, although timely corrections may qualify for reduced penalties.

The first mandatory deadline arrives after the close of 2026. The IRS’s 2026 W-2 instructions list February 1, 2027, as the deadline for filing Forms W-2 and W-3 with the SSA and furnishing employee statements. Employers should review vendor readiness, establish an audit trail for the premium calculation, and give workers a process for challenging an omission or understatement. Employees may also submit an updated Form W-4 to reflect an expected deduction, but that withholding election does not relieve the employer of accurate reporting.