Tips and Overtime: What 2026 W-2s Report and What Workers Deduct
Starting with 2026, the Form W-2 you give each employee has to show qualified overtime, tips and tipped occupation codes on their own lines. For 2025, the IRS waived penalties for employers who did not report these amounts separately. That relief covers only 2025.
Our year-end checklist also flags the change. The harder part is that the numbers come from payroll records kept during the year. If your system cannot separate them yet, the fourth quarter is the time to fix it, while pay periods remain. Here is what workers can deduct, what you report, and what to set up now.
What workers can deduct
Workers can deduct up to $25,000 of qualified tips per return. Separately, they can deduct up to $12,500 of qualified overtime pay, or $25,000 on a joint return. Both deductions shrink by $100 for every $1,000 of modified adjusted gross income above $150,000, or $300,000 for joint filers. They apply for 2025 through 2028.
The worker needs a valid Social Security number on the return, and a married worker must file jointly. The deductions are available whether or not the worker itemizes.
These are deductions on the worker's own return, not exclusions from pay. Tips and overtime are still wages. You withhold income tax and collect Social Security and Medicare taxes on them as before. An employee who expects a deduction can give you a new Form W-4 to reduce withholding.
Which tips qualify
Qualified tips are voluntary cash or charged tips, including amounts received through tip sharing. The customer decides the amount. Automatic gratuities and mandatory service charges are not qualified tips, and the amounts you pass to staff are generally treated as regular wages. If you use tip prompts on a card reader or tablet, make sure the customer can choose zero.
The tips also have to be earned in an occupation on Treasury's list. Final regulations issued in April 2026 list 71 occupations in eight groups, each with a three-digit Treasury Tipped Occupation Code. Bartenders, wait staff, hairstylists, manicurists and delivery workers are on it. So are cooks and dishwashers, which matters if they share in a tip pool.
Only federal overtime counts
Qualified overtime is the premium part of overtime that the federal Fair Labor Standards Act requires. For most hourly employees, that is half the federal regular rate for each hour over 40 in a workweek, the "half" in time-and-a-half. The regular rate can be higher than the hourly wage, because it includes pay such as nondiscretionary bonuses.
The IRS says overtime paid only because of state law, a union contract or company policy does not count. Only the amount the federal law requires does. That matters in California, where overtime starts after eight hours in a day and double time after 12. On a standard schedule, a worker with one 10-hour day in a 36-hour week earns two hours of California overtime and no qualified overtime. When double time covers hours over 40 in the week, only the half-time premium counts.
Employees who are exempt from federal overtime rules have no qualified overtime, even if you choose to pay them extra. In general, that includes an owner who holds at least 20 percent of the business and actively manages it.
What changes on the 2026 W-2
Box 12 has three new codes. Code TP shows the total cash tips employees reported to you. Code TT shows qualified overtime. Code TA shows employer contributions to Trump accounts. Box 14 is now split, and the new box 14b holds the Treasury Tipped Occupation Code. Forms 1099-NEC and 1099-MISC have new boxes for tips, occupation codes and overtime as well.
These lines carry weight. For 2026 and later, the IRS says an employee can deduct only the qualified overtime the employer reports on a properly furnished W-2. If box 12 is wrong, the fix is a Form W-2c.
What to set up in payroll now
Start with the job list. Match each tipped position to its occupation code, and decide how you will handle employees who work more than one role. Check menus and card readers for automatic gratuities, and record service charges apart from tips.
Then look at how pay is coded. Most payroll systems will need separate earnings codes for cash tips, charged tips, tip-pool payouts and service charges. For overtime, the system has to separate the federal premium from overtime paid only under California rules, using the federal regular rate. Ask your provider whether it calculates qualified overtime itself or relies on your setup.
Finally, test it. Run a year-to-date report now and compare it with timecards for a few employees. Fixing a full year of coding in January is much harder than catching problems before year end.
What to tell employees
Tell them the deductions are claimed on their own returns, that withholding and payroll taxes have not changed, and that they can update their Form W-4. Remind them about the income limits, the Social Security number rule and the joint filing rule.
California does not allow either deduction, so tips and overtime stay fully taxable for state income tax. Bills to create a California version were held in committee in 2026. For 2025, if a W-2 does not break these amounts out, the IRS lets workers figure them from other records, such as tip reports and pay stubs.
If you own a salon, spa or barbershop, one employer rule changed too. The federal credit for Social Security and Medicare taxes paid on tips, once limited to food and beverage businesses, now covers barbering, hair care, nail care, esthetics, and body and spa treatments, starting with 2025 tax years.
Book a planning call
If you want help checking your payroll setup before year end, book a time with our team at calendly.com/kirkcole/15-minute-meeting. Bring a recent payroll register and a list of your tipped and hourly positions.
This article is general information, not tax advice for your situation. Tax rules change, and the right move depends on your facts.