No Tax on Overtime: What Employers Must Track and Report on the W-2 (Code TT)

Under the One Big Beautiful Bill Act, employees can deduct up to $12,500 ($25,000 if filing jointly) of qualified overtime compensation for tax years 2025 through 2028, and employers must report it on Form W-2, Box 12, with code TT starting with tax year 2026. Only the FLSA-required premium, the "half" in time-and-a-half, qualifies. Accurate time records that separate FLSA overtime from other pay are now a tax-reporting need as well as a wage compliance need.

This guide explains what counts, what does not, how to calculate the qualifying amount with a worked example and what your time system needs to capture. The IRS has issued guidance, including FAQ update FS-2026-13 in August 2026, so confirm the latest instructions with the IRS or a tax professional. This is general information, not legal or tax advice.

What the deduction covers

The deduction is for "qualified overtime compensation," and it applies to overtime that the FLSA requires. For a given hour of overtime, the qualifying portion is the premium, meaning the extra half of the 1.5 rate, and not the straight-time portion already included in regular pay.

The deduction is taken by the employee on the tax return, up to $12,500 ($25,000 for joint filers), and it phases out for modified adjusted gross income above $150,000 ($300,000 joint). It applies for tax years 2025 to 2028. Employees may take it whether or not they itemize.

Because the deduction applies to the employee's return, your role is to give accurate information, not tax advice. Encourage employees to consult a tax professional about their own situation, particularly if their income is near the phase-out range.

What does not qualify

Overtime pay required only by state law, such as California daily overtime over 8 hours in a day when the employee does not exceed 40 in the week, does not qualify, because it is not overtime required by the FLSA. Double-time premiums that go beyond what the FLSA requires also do not qualify to the extent they exceed the 0.5 premium.

Overtime that an employer pays voluntarily, such as a premium for the first 38 hours, or hours under 40 that are paid at a higher rate under a contract, is not FLSA-required overtime either. Exempt employees generally do not have FLSA overtime at all. We cover the exemption tests in exempt vs. nonexempt employees.

A step-by-step calculation

Say an employee earns $20.00/hour and works 46 hours in a workweek. Straight-time pay for all hours: 46 x $20.00 = $920.00. FLSA overtime hours: 46 - 40 = 6. Overtime premium: 6 x ($20.00 x 0.5) = 6 x $10.00 = $60.00. Total pay is $920.00 + $60.00 = $980.00, of which only the $60.00 is qualified overtime compensation.

Over a year, if the employee has such a week 40 times, the qualifying amount is 40 x $60.00 = $2,400.00, which is far below the $12,500 cap. The deduction would reduce taxable income by $2,400.00, subject to the income phase-out.

The first example is simple because one rate applies. In real payroll, a week can include different rates, a shift differential and a nondiscretionary bonus, in which case the regular rate must be recalculated before the premium is found. The time data feeding that calculation has to be right to the minute.

A California example

Suppose a California employee earning $25.00/hour works 10 hours on one day and 30 hours across the other four days, 40 hours in the week. California requires daily overtime for the 2 hours over 8: 2 x $25.00 x 1.5 = $75.00 for those hours. But the employee did not exceed 40 hours in the workweek, so there is no FLSA overtime, and no qualified overtime compensation under the federal definition.

If the same employee works 48 hours in the week, FLSA overtime is on the 8 hours over 40, and the qualifying premium is 8 x $12.50 = $100.00. Your system must be able to show the 40-hour weekly calculation separately from state daily overtime.

Employer reporting: W-2 Box 12, code TT

Employers report the total qualified overtime compensation paid to the employee for the year in Box 12 of Form W-2 using code TT, starting with tax year 2026. For 2025, the IRS provided transition relief, so reporting rules for that year were more lenient. Check the current IRS instructions and FS-2026-13 for the exact requirement and any guidance on estimating or substantiating the amount.

Whether your payroll software computes code TT automatically depends on the provider, so ask. Do not assume your time system can file this on its own. It can, however, give your payroll team the accurate weekly overtime hours it needs.

Regular rate errors now matter twice

The premium is based on the regular rate, which includes nondiscretionary bonuses and shift differentials (29 CFR Part 778). If you leave a bonus out of the regular rate, you underpay overtime and you also understate the qualified overtime figure, which cuts the employee's deduction. See FLSA timekeeping requirements for the records that support the calculation.

Employees will check their W-2 Box 12 against their expectations. Clean records let you answer questions about how the figure was calculated.

Plan ahead for year-end. Run a report of FLSA overtime hours by employee in December, compare it with payroll totals and resolve differences before W-2s are issued. Fixing a mismatch in January is much easier than correcting forms after they have been filed.

What your timekeeping system needs

- Daily and weekly hours for each employee, recorded as they are worked.

- A fixed workweek definition so the 40-hour test is applied the same way every week.

- Separation of FLSA overtime from state-only daily overtime and other premiums.

- Shift differentials and bonuses that feed the regular rate.

- Audit trails for edits and approvals, so the year-end total is defensible.

How SimpleWorkshift Helps With Overtime Tracking

SimpleWorkshift records hours as employees clock in and out from the iOS or Android app or the web, with a GPS location on each entry, and calculates overtime automatically, including night shift differentials. Custom reports let you pull weekly hours and overtime by employee, so your payroll team has accurate inputs for the year-end figures.

SimpleWorkshift does not file Form W-2 or compute code TT on its own, so use its reports together with your payroll provider or tax professional. Payroll closing and real-time exceptions help you catch errors early. Try it free for 30 days at simpleworkshift.com, with no contracts and the option to cancel anytime.