No Tax on Tips and Overtime in 2026: What Employers Must Track Now
The One Big Beautiful Bill Act (Public Law 119-21) created new deductions for qualified tips and qualified overtime compensation for tax years 2025 through 2028. (Source)
If you’re an employer, 2025 was the messy transition year. 2026 is the first operational year where payroll and year-end reporting are expected to cleanly feed the deduction claims, because forms and reporting fields are now updated and required. (Source)
Let’s separate the two timelines people constantly mash together:
Tax season 2026 (filing 2025 returns): employees claim the new deductions on Schedule 1-A (Form 1040/1040-SR) using whatever documentation they can pull together.
Payroll year 2026 (wages paid in 2026): employers must track and separately report qualified tips and qualified overtime using new W-2 codes and fields, making the process much less “guess-and-pray.” (Source)
And the big reality check:
This is not “tax-free paychecks.” These are income tax deductions claimed on the tax return. Tips and overtime are generally still subject to withholding mechanics and FICA.
2026 reporting: the new W-2 codes you need to implement
For 2026 Forms W-2 and W-3 (used to report 2026 wages), the IRS added new reporting requirements:
Tips: Box 12 Code TP + Box 14b occupation code
Box 12, Code TP: total amount of cash tips reported to the employer
Box 14b: Treasury Tipped Occupation Code(s) (TTOC) for the employee
Box 14 is now split into 14a (Other) and 14b (TTOC)
Overtime: Box 12 Code TT
Box 12, Code TT: total amount of qualified overtime compensation
Also worth noting: the IRS confirms overtime and tips are generally still subject to federal withholding and both employer and employee FICA.
“No Tax on Tips” in 2026: what counts, and what does not
Qualified tips (in plain English)
Qualified tips are cash tips, including voluntary cash or charged tips received from customers, including tip-sharing. Mandatory service charges are not qualified tips.
The occupation gate matters now
The tips deduction is limited to tips received in occupations that customarily and regularly received tips on or before December 31, 2024. The IRS maintains the occupation list and Treasury issued proposed regulations on the definition and list.
For payroll in 2026, you need to map each tipped employee to the correct Treasury Tipped Occupation Code for W-2 reporting.
“No Tax on Overtime” in 2026: the part you actually have to calculate
Qualified overtime is only the premium
Qualified overtime compensation is the portion that exceeds the regular rate required under FLSA section 7 (the “half” part of time-and-a-half).
If you want the statutory backbone for how overtime is defined and required, the DOL’s overtime rules and FLSA framework are the anchor. https://www.irs.gov/newsroom/one-big-beautiful-bill-act-tax-deductions-for-working-americans-and-seniors
2026 and later: separate reporting is required
The IRS is explicit:
2025: separate reporting not required
2026 and later: employers and other payers are required to separately report qualified overtime compensation, and Forms W-2, 1099-NEC, and 1099-MISC are updated to allow it (Source)
That is why 2026 is the year to fix your earning codes and timekeeping logic.
What employees do in 2026 filing season (so you can answer the questions)
Employees claiming the deduction for 2025 income are pointed to Schedule 1-A and IRS guidance that explains what documentation can support the claim when separate reporting was not provided.
Give them this sentence (it’s accurate and calming):
“In 2026, you claim the deduction on Schedule 1-A with your tax return. For 2026 wages and later, our W-2 will include separate codes that make this easier.”
Employer action list for 2026 payroll (the part that keeps you out of trouble)
Create distinct earning buckets now
Cash tips (for TP)
Qualified overtime premium (for TT)
Non-qualified tips (service charges, automatic gratuities) tracked separately
The W-2 instructions give you the destination, your payroll system has to provide the road.
Implement TTOC mapping for tipped roles
You need a defensible mapping from job title to the IRS/Treasury tipped occupation list and code. (Look here)Timekeeping needs “regular rate” clarity
If your overtime calculations get weird (bonuses, different rates, blended rates), your “premium portion” needs to be auditable.Update year-end workflows and deadlines
The IRS W-2/W-3 instructions list a February 1, 2027 due date for filing 2026 W-2s with SSA and furnishing employee copies (because of the calendar). Put that on your compliance calendar now. (Source)Train managers on the “not tax-free paycheck” point
Your frontline managers will accidentally promise “no tax” unless you script them.
FAQ
Are tips and overtime exempt from payroll taxes in 2026?
No. They are generally still subject to withholding mechanics and FICA. The law creates income tax deductions claimed on the return.
What changes for employers in 2026?
Separate reporting becomes real: W-2 reporting adds TP for cash tips, TT for qualified overtime, and Box 14b for tipped occupation codes.
How do we know if a role is a tipped occupation?
Use the IRS occupation list and Treasury’s proposed regulations defining occupations that customarily and regularly received tips. (Look here)
Get a defensible tax position, not vibes.
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