Regular Rate Audit

No Tax on Overtime: Employer Reporting Requirements for 2026

By Nick Peterson — software engineer; I build payroll-audit computation. Educational information, not legal or tax advice. Every claim links a primary source. Updated July 30, 2026 — reviewed against IRS Notice 2025-69, Notice 2025-62, and the 2026 W-2/W-3 instructions.

"No tax on overtime" is marketed as an employee benefit, but it runs on a number only the employer can produce. Starting with tax year 2026, that number — qualified overtime compensation — must appear on every affected W-2 in Box 12 under new code TT. The first forms carrying it go out in January 2027.

If you manage payroll, this page is the compliance picture in one place: the timeline, what the number actually is (narrower than "overtime wages"), why it depends on a rate your system may not compute correctly, the questions to put to your payroll vendor in writing, and a five-step dry run to complete before January.

You can pressure-test the core computation on your own numbers in about a minute with the free TT calculator.

The requirement timeline: 2025 was the grace period, 2026 is not

The One Big Beautiful Bill Act (OBBBA, July 2025) created a federal income-tax deduction for overtime pay for tax years 2025 through 2028: employees can deduct up to $12,500 ($25,000 married filing jointly) of qualified overtime compensation, phasing out above $150,000/$300,000 MAGI (IRS Q&A). The employer's side of the bargain arrives in three stages:

PeriodEmployer obligationAuthority
Tax year 2025 Transition year. The W-2 was not modified; reporting was not required, and information-reporting penalties were waived. Employees were told to estimate their own deduction from pay stubs. Notice 2025-62 (penalty relief); Notice 2025-69 (employee estimation methods)
Tax year 2026 Mandatory reporting. Box 12 code TT carries "the total amount of qualified overtime compensation." The 2025 penalty relief was not extended; IRC §§6721/6722 penalties apply — $340 per form for tax-year 2026 returns, and for intentional disregard the greater of $690 per form or 10% of the amount required to be reported, with no maximum (Rev. Proc. 2025-32) — counted separately for the filed return and the employee statement. 2026 General Instructions for Forms W-2/W-3 (final)
After 2028 The deduction sunsets. OBBBA §70202

The practical deadline is earlier than January 2027. The TT figure is a full-year accumulation over data your system generates every workweek — if the accumulation isn't running (or isn't right) by early in the year, year-end becomes a reconstruction project. Which is why the rest of this guide is about what the number is and where systems get it wrong.

What code TT actually is: a defined term, not your OT line

Qualified overtime compensation is defined in IRC §225(c) as overtime compensation required under section 7 of the FLSA that is in excess of the regular rate (Notice 2025-69 §II.B). The 2026 W-2 instructions compress it to one phrase: code TT reports "the 'and-a-half' portion of time-and-a-half compensation."

That definition applies two filters, and each one removes dollars a payroll manager might assume are in:

So code TT is not a re-labeling of your overtime earnings code. It is a federal-law computation over the workweek — a partition of time most payroll systems don't report on natively — and it captures a slice of the OT line, not the line itself. The full exclusion analysis, including the California layers, is in the companion code TT employer guide; the step-by-step arithmetic with five worked examples is in how to calculate qualified overtime compensation.

The regular-rate dependency: the box holds a premium on a rate, not "overtime wages"

Here is the part that makes TT a computation problem rather than a mapping problem. The FLSA premium is 0.5 × the regular rate of pay — not 0.5 × the hourly wage — and the regular rate is recomputed every workweek:

regular rate = all includable remuneration for the workweek ÷ total hours worked that week

"Includable" is broad by design (29 USC §207(e); DOL Fact Sheet #56A): nondiscretionary bonuses (attendance, production, safety, retention — anything promised or expected, per Fact Sheet #56C), commissions, shift differentials, on-call pay. The regulation's own example at 29 CFR 778.110(b) runs the arithmetic: $12/hour, 46 hours, a $46 production bonus → a $13.00 regular rate, and overtime premiums owed on $13, not $12.

Concretely: an employee at $20/hour working 50 hours with a $200 attendance bonus has a regular rate of ($1,000 + $200) ÷ 50 = $24.00, so the week's qualified overtime compensation is 0.5 × $24 × 10 = $120.00. A system that computes the premium on the $20 base reports $100 — understating Box TT by $20 and underpaying the employee by the same $20 (run your own week in the calculator).

This is also why the shortcut you've probably heard about — report total overtime pay ÷ 3 — doesn't survive contact with the source documents:

  1. The ÷3 method in Notice 2025-69 (method (B)) was employee-side relief for estimating a personal deduction from pay stubs.
  2. It was for tax year 2025 only — "This notice applies to the 2025 tax year" — and the OBBBA's transition rule (§70202(h)) permits approximation only for periods before January 1, 2026. No estimation method has been blessed for TY2026 employer W-2 reporting.
  3. Method (E) of the same Notice concedes that ÷3 "would result in underestimating the employee's qualified overtime compensation (for example, because the individual's regular rate is increased by a nondiscretionary bonus)." If your workforce earns bonuses or differentials, the IRS has already described, in print, how the shortcut fails.

Questions to ask your payroll vendor — in writing, before Q4 close

Most payroll managers will not build this computation by hand; they will rely on their vendor's TT support. The gap between "we support code TT" and "we compute it correctly on your pay codes" is exactly where the exposure lives. Five questions that surface the difference:

  1. The premium question. "Can the system isolate the FLSA-required 0.5× premium, computed on a §207(e)-complete regular rate, separately from state-law and contractual overtime — per workweek?" This is the whole requirement in one sentence; a yes should come with a demonstration.
  2. The workweek question. "Our pay periods are biweekly/semimonthly — does the TT accumulation run on FLSA workweeks, not pay periods?" The regular rate is a per-workweek figure (29 CFR 778.110); semimonthly periods don't divide into workweeks evenly.
  3. The pay-code question. "Which of our earning codes flow into the overtime rate today?" Ask for the actual mapping. Nondiscretionary bonuses, commissions, and shift differentials belong in the rate (DOL Fact Sheet #56A); a system paying OT on base rate alone is producing the understated number the IRS described.
  4. The retroactive-bonus question. "When a quarterly or annual nondiscretionary bonus pays out, does the system reopen the closed workweeks, allocate the bonus back, and pay the additional half-time premium — and does that true-up flow into the TT accumulation?" That replay is required by 29 CFR 778.209, and batch payroll systems that close periods forward rarely perform it.
  5. The audit question. "Can we extract the year-to-date TT accumulation mid-year, per employee, with the workweek detail behind it?" If you can't see the number until W-2 season, you can't check it until it's too late to fix cheaply.

Get the answers in writing. If guidance shifts or a number is challenged later, a documented, consistently applied methodology is the defensible position; an undocumented shortcut is not.

The five-step dry run to finish before January

  1. Inventory pay codes. List every earning code and mark it includable in the regular rate or excludable under §207(e) (Fact Sheet #56A). Almost every bonus your managers would describe as "expected" is includable (Fact Sheet #56C).
  2. Put the vendor questions above in writing and calendar the follow-up. An answer in October is a project; the same answer in January is a crisis.
  3. Pick and paper a methodology. Exact computation from workweek data, or a documented method with known limits — decided and written down, not improvised at year-end.
  4. Run a TY2026 dry run on real data. Take one quarter of payroll registers and time data, compute the TT figure per employee, and reconcile it against what the system would report. The size of the gap is the size of the January problem — and, because the same premium is a wage obligation, of the underlying overtime exposure. (This reconciliation is exactly what the free exposure snapshot does, employee by employee, pay code by pay code.)
  5. Track guidance monthly. The IRS could still extend relief; as of July 2026 it has not, and the 2026 W-2 instructions are final. If relief arrives, the reporting pressure eases — the wage-and-hour liability underneath does not move.

Start with one week of your own numbers in the TT calculator — or request a free exposure snapshot: I run the full computation on a quarter of your actual payroll register and punch data and show you the gap, employee by employee, pay code by pay code. Request a snapshot →

FAQ

When do employers have to start reporting overtime for the "no tax on overtime" deduction? Tax year 2026. The finalized 2026 General Instructions for Forms W-2 and W-3 establish Box 12 code TT for "the total amount of qualified overtime compensation"; the first W-2s carrying it go out in January 2027. For tax year 2025, reporting was not required and Notice 2025-62 waived the information-reporting penalties — that relief was not extended to 2026.

What amount goes in W-2 Box 12 code TT? Only the FLSA-required overtime premium — what the 2026 W-2/W-3 instructions call "the 'and-a-half' portion of time-and-a-half compensation": the 0.5× increment above the regular rate, for hours over 40 in a workweek. The 1.0× straight-time portion, state-law-only overtime, and contractual overtime the FLSA doesn't compel are all excluded (Notice 2025-69 §II.B).

Can an employer report total overtime pay divided by 3 for 2026? No estimation method has been blessed for tax year 2026 employer W-2 reporting. The ÷3 method in Notice 2025-69 was guidance for employees estimating their own 2025 deduction ("This notice applies to the 2025 tax year"), and the Notice's method (E) states in writing that ÷3 underestimates qualified overtime compensation when a nondiscretionary bonus raises the regular rate.

What are the penalties for a wrong or missing code TT amount? Standard information-return penalties under IRC §§6721/6722 — $340 per form for tax-year 2026 returns, and for intentional disregard the greater of $690 per form or 10% of the amount required to be reported, with no maximum (Rev. Proc. 2025-32) — counted separately for the filed return and the employee statement. Separately, if the TT number is wrong because the regular rate is wrong, the same error usually means overtime itself was underpaid — a wage-and-hour exposure with a 2–3 year federal lookback.

Does overtime required only by state law count as qualified overtime compensation? No. Qualified overtime compensation covers only overtime required under FLSA section 7 (Notice 2025-69 §II.B). California daily overtime in a week under 40 hours contributes $0 to code TT, and for California double time only the FLSA's 0.5× slice of hours over 40 counts — the Notice states that payments in excess of the FLSA-required premium are not qualified.

What should employers ask their payroll vendor before January? In writing: can the system isolate the FLSA-required 0.5× premium, computed on a regular rate that includes all §207(e) remuneration (nondiscretionary bonuses, commissions, shift differentials), separately from state-law and contractual overtime, per workweek? Get the answer before Q4 close — the first code TT W-2s go out in January 2027 per the 2026 W-2/W-3 instructions.

Sources: IRS Q&A: qualified overtime deduction · IRS Notice 2025-69 · IRS Notice 2025-62 (IRB 2025-48) · 2026 General Instructions for Forms W-2/W-3 · DOL Fact Sheet #56A · DOL Fact Sheet #56C · 29 CFR 778.110 · 29 CFR 778.209

Not legal or tax advice. Written by an engineer who builds the computation; methodology and test cases are public. Attorney review pending — this page will carry the reviewer's byline when it does.