Take Note – Mandatory Reporting of Employees’ Qualified Overtime Compensation for 2026
The IRS recently released the final version of the 2026 Form W-2, incorporating new reporting requirements mandated by Public Law 119-21, commonly known as the One Big Beautiful Bill Act (OBBBA). In order to align with the new employee overtime deduction, the revised 2026 Form W-2 requires employers to report an employee’s total “qualified overtime compensation” in Box 12 with new code “TT.” These requirements apply to all employers, including private sector businesses and governmental bodies.
The standard incorrect information return penalties for an employer who fails to comply with these new federal filing requirements for 2026 is $680 per incorrect return filed subject to annual caps. However, if the IRS believes there is evidence of knowing or deliberate noncompliance, i.e. in a context in which the employer cannot show the incorrect filing was due to simple negligence, misunderstanding, programming error or inadvertent error, the employer may be exposed to the enhanced “intentional-disregard” information-return penalties under IRC §§ 6721 and 6722. For 2026, the enhanced penalty is the greater of $680 per incorrect return with no annual cap or 10% of the aggregate amount of qualified overtime compensation that should have been reported in Box 12. The IRS may also impose a second $680 penalty for each copy of the W-2 that an employer furnished to its employees containing incorrect Box 12 information.
There is an elevated risk of exposure to the “intentional disregard” penalties for noncompliant employers.
Impact on Employer’s Payroll Systems
Because the new employee overtime deduction became effective retroactively in 2025 and the IRS did not revise the 2025 Form W-2, it treated 2025 as a transitional year. In Notice 2025-62,the IRS acknowledged that many employers lacked the systems and data necessary to comply and announced that it would not penalize employers for failing to separately report “qualified overtime compensation” on the 2025 Form W-2 provided that the form was otherwise complete and accurate. The IRS cautioned that this penalty relief was only for 2025 and that employers should begin to make the necessary adjustments to their payroll systems to track “qualified overtime compensation” and prepare for expanded IRS reporting requirements beginning in 2026.
Separately, in Notice 2025-69, the IRS permitted employees to use various methods to determine their overtime deduction for 2025 if their employers did not provide separate accounting of qualified overtime compensation. Beginning in 2026, employees should be able to rely on the accuracy of the overtime compensation reported by their employers in Box 12 in determining whether, and the extent to which, they qualify for the deduction in completing their individual income tax returns.
The revised instructions to the 2026 Form W-2 require an employer to report the “premium” portion of an employee’s Fair Labor Standards Act (FLSA) required overtime pay (the so-called “and a half” portion) - not the employee’s total overtime earnings and only that portion of the premium that is required to be paid under the FLSA – not any amount of the premium that is in excess of the FLSA required amount of overtime compensation. In general, a nonexempt employee must receive 1.5 times the employee’s “regular rate” of pay for work in excess of 40 hours in a workweek (different work period and maximum hour requirements can apply to certain public safety employees). Some employers, however, pay overtime in excess of the amount required by the FLSA pursuant to collective bargaining agreements, State overtime laws or their own policies. Any amount in excess of the FLSA required overtime compensation is nonqualified overtime compensation, which should not be reported in Box 12.
Modifying a payroll system to track the new Box 12 qualified overtime premium reporting requirements becomes significantly more challenging for an employer subject to the FLSA that pays overtime using a non-FLSA overtime pay formulation. For example, some employers pay overtime for hours worked in excess of 8 hours per day or 37.5 hours per week. Also, the FLSA does not require overtime simply because work occurs on a weekend or holiday, which may differ from an employer’s contractual obligations or its own compensation policies. Therefore, in order to accurately report Box 12 overtime data, the payroll system will have to determine the FLSA required amount of overtime as a separate data point to calculate the premium portion as an upper limit on the amount it reports as qualified overtime compensation in Box 12.
Some employers in this situation might be tempted to think that there is an implicit “no-harm-no-foul” defense if they report nonqualified overtime compensation in Box 12 so long as the amount exceeds the employee’s overtime pay deduction limit. For other employees, it can make a manual adjustment to report only qualified overtime compensation. Aside from the legal risk of noncompliance, both of these approaches ignore the complexity of the employee’s deduction limit.
The limit is $12,500 for employees filing individually and $25,000 for married employees filing jointly. Furthermore, the deduction limit is phased out when the employee’s modified adjusted gross income (MAGI) exceeds $150,000 for employees filing individually and $300,000 for married employees filing jointly. Such a process presumably would require the employer to assess the marital and tax filing status of each employee for whom it reports overtime compensation in Box 12 as of the end of the tax year and an approximation of their MAGI in order to determine whether and the extent to which the statutory limit is subject to a phase out. As a practical matter, this is not a feasible alternative to making the necessary modifications to an employer’s payroll system to accurately report “qualified overtime compensation” in Box 12 coded “TT.”
The IRS has been known to issue guidance during the third quarter of a tax year that may provide additional penalty relief. There is no basis for assuming this will take place for 2026 regarding Box 12 reporting, but it is not entirely free from doubt. To date the published guidance strongly indicates that employers were given a reasonable grace period for 2025 to make the necessary changes and the IRS expects full compliance in 2026 and thereafter until this part of the OBBBA sunsets on December 31, 2028, unless Congress extends this provision.
For more information or for any questions, please contact Philip Koehler.
