The One W-2 Box That Decides Whether Your Employees Get the Overtime Deduction

Most tax rules give you a second chance. This one does not.

Starting with the 2026 tax year, an employee can only claim the deduction for qualified overtime compensation if the amount appears on their Form W-2. Not if they can prove it. Not if their pay stubs show it. It has to be on the W-2, in Box 12, using code TT. If it is not there, the deduction is gone, and the only way to fix it is for the employer to issue a corrected W-2.

The IRS updated its guidance on this deduction on August 6, and the update makes the reporting requirement unambiguous. If you run payroll for hourly employees, you have roughly four months of pay periods left to make sure your system is capturing the right number.

What the deduction actually is

The Working Families Tax Cuts created a deduction for qualified overtime compensation. It is worth up to $12,500 per year on a single return and $25,000 on a joint return. The deduction begins to phase out once modified adjusted gross income exceeds $150,000, or $300,000 for joint filers.

It is claimed on Schedule 1-A of Form 1040, which means employees do not need to itemize to benefit from it.

A few eligibility details catch people off guard:

• The employee must be nonexempt under the Fair Labor Standards Act. Salaried exempt employees who work long hours get nothing here, no matter how many hours they work.
• Employee-owners holding 20% or more equity are excluded. If you own a quarter of the S corp and also work hourly, you do not qualify.
• A Social Security number valid for employment is required, issued before the due date of the employee’s return, including extensions.
• Married employees must file jointly to claim it.

The part that surprises employers: it is only the premium

This is where payroll systems get it wrong.

Only overtime required by Section 7 of the FLSA qualifies, and only the premium portion. The math is:

Hours over 40 in the week × 0.5 × the employee’s FLSA regular rate

So if an employee earns a $20 regular rate and works 50 hours, the qualified overtime is 10 hours × 0.5 × $20 = $100. Not the $300 of time-and-a-half wages. Just the half-time premium.

Pay above what the FLSA requires does not fully count either. If you pay double-time on Sundays as a matter of company policy, only the portion minimally necessary to satisfy FLSA requirements is qualified overtime. The rest is ordinary wages.

Two common errors follow from this. Some systems report the entire overtime gross, overstating the number. Others report nothing at all, because the premium was never tracked as a separate component. Both create problems, and the second one costs your employees money.

One more detail worth knowing: you report the full qualified amount you paid, even if it exceeds $12,500. The cap is applied on the employee’s return, not by your payroll system.

Why 2026 is different from 2025

For the 2025 tax year, the IRS provided transition relief. Employees could claim the deduction even if the amount was not separately reported on the W-2, using a reasonable method to determine it.

That relief has expired. For 2026, the deduction is available only for amounts included on the statement the employer is required to furnish. A substitute Form 4852 does not satisfy the requirement. Estimates do not satisfy it. The number has to be on the W-2 you file in January.

The tips deduction operates on the same logic, and qualified tips must be separately reported on the employee’s W-2 as well. If you have tipped employees, the same year-end review applies.

What to do in September, not January

Waiting until W-2 season is the expensive choice. Here is the sequence that works:

• Confirm your payroll provider is tracking the FLSA premium as a distinct component. Ask them directly whether they will populate Box 12 code TT, and ask them to show you a sample. Handled is not an answer.
• Run a test W-2 now. Most providers can generate a preview. Check one hourly employee with regular overtime and verify the code TT figure matches the half-time premium calculation above.
• Audit your FLSA classifications. If someone is misclassified as exempt, they are losing a deduction on top of any wage-and-hour exposure you already have.
• Check any pay above FLSA minimums. Double-time, weekend premiums, and contractual overtime need to be split between qualified and non-qualified.
• Fix the first three quarters. If your system has not been tracking this since January, the historical premium needs to be reconstructed before year-end close, not after.
• Tell your employees. A short note explaining that overtime premiums are now separately reported, and what the deduction is worth, is a genuine benefit at no cost to you.

The bottom line

This is a reporting problem, not a tax-planning problem, which makes it easier to solve and less forgivable to ignore. The employee bears the cost of an employer’s payroll error, and the fix after the fact is a corrected W-2 for every affected worker.

Four months of pay periods is plenty of time. Four weeks in January is not.

If your payroll setup needs a second look

Holloway Financial Group works with business owners year-round on exactly this kind of thing, the details that are cheap to fix in September and costly in February. If you would like us to take a look at where you stand, the fastest way to start is our new client application. It takes a few minutes and gives us what we need to give you a straight answer.

Start your new client application

This article is general information, not advice for your specific situation. Overtime classification and payroll reporting depend on facts we would need to review. Sources: IRS IR-2026-88 (Aug. 6, 2026); IRS Fact Sheet FS-2026-13, revising FS-2026-01; IRS Notice 2025-69.