The IRS has released new guidance affecting how employers must track and report certain types of employee compensation, specifically qualified overtime and qualified tips. These changes stem from the One Big Beautiful Bill Act (OBBBA), signed into law in July 2025, and will impact payroll processing and W-2 reporting over the next two years.
This summary outlines what your business needs to know as you prepare for year-end and plan ahead for 2026.
What Is Changing?
Two new categories of compensation now carry potential federal tax deductions for employees:
- Qualified Overtime Compensation
This is the overtime premium portion required under federal law (FLSA) for hours worked over 40 in a workweek.
- Qualified Tips
These are employee-reported tips — cash or charged — that employers already include in wages for payroll tax purposes.
To support employees claiming these new deductions, businesses must begin tracking these amounts.
2025: Transition Year With IRS Penalty Relief
The IRS issued Notice 2025-62, confirming that:
– The 2025 Form W-2 will NOT be updated to include new boxes or codes for qualified overtime or qualified tips.
– Employers will not face penalties in 2025 for failing to report these amounts separately on the W-2, as long as all other information is complete and accurate.
– Even though reporting is not required for 2025, the IRS encourages employers to provide totals to employees through either:
- Box 14 on Form W-2, or
- A separate year-end statement
Providing this information helps employees claim the new deductions on their 2025 individual tax returns.
2026: Full Mandatory Compliance Begins
Significant changes are coming to the 2026 Form W-2, including:
New Box 12 Codes:
– TP – Qualified Tips
– TT – Qualified Overtime Compensation
New occupational code requirement for tipped employees.
Employers will need to ensure their payroll systems can track these amounts throughout 2026 and report them in the newly designated fields.
What Employers Should Do Now
For 2025:
– Begin tracking qualified overtime and qualified tips separately.
– Decide whether to report these amounts in W-2 Box 14 or provide a separate employee statement.
– Review payroll procedures to ensure accurate FLSA overtime calculations and tip reporting.
For 2026:
– Confirm that payroll software vendors will support the new required reporting fields.
– Prepare to include the new W-2 codes (TP and TT) beginning with wages paid January 1, 2026.
– Update internal payroll practices to ensure accurate year-round tracking.
We’re Here to Help
These new reporting rules introduce additional complexity to year-end processing, payroll tracking, and employee communication. Our team is actively monitoring IRS updates and working with clients to ensure a smooth transition.
If you have questions about how these changes affect your business, your payroll setup, or your W-2 reporting, please reach out — we are happy to assist.
