## The Grace Period Is Over
When the One Big Beautiful Bill Act (OBBBA) was signed on July 4, 2025, it created two new employee tax deductions: no tax on qualifying tips and no tax on qualifying overtime compensation. The political headlines were loud. The compliance fine print was quieter.
Buried inside those deductions is a reporting obligation that falls entirely on **employers**: OBBBA W-2 reporting requires you to separately break out qualified overtime and qualified tips — using new Box 12 codes — on every affected employee's W-2 starting with the 2026 tax year. The IRS issued IRS Notice 2025-62 acknowledging that payroll systems needed time to catch up and granted 2025 as a penalty-free grace year.
That grace period ended January 1, 2026.
If your company has hourly workers who earn overtime, or employees in tipped occupations, your payroll system needs to be capturing and coding these figures correctly — right now, for wages paid today — or your January 2027 W-2 filing will be incomplete. Penalties run **$60 to $680 per affected W-2**.
Two New W-2 Box 12 Codes
The IRS added two new Box 12 codes for the 2026 W-2:
- **Code TT** — Qualified overtime compensation (the FLSA overtime premium only)
- **Code TP** — Qualified tips (voluntary tips received in a Treasury-recognized tipped occupation)
These are not optional line items. If you pay qualified overtime or employ workers who receive qualified tips, the amounts must be coded in Box 12 alongside the employee's total wages in Box 1. Omitting these codes on an otherwise-correct W-2 constitutes an incomplete filing.
Draft IRS W-2 instructions also introduce a **Treasury Tipped Occupation Code (TTOC)** — an employer-assigned code that corresponds to the IRS's approved list of tipped occupations. You must provide the applicable TTOC to each tipped employee.
What Counts as Qualified Overtime (Code TT)
This is where most payroll systems need reconfiguration. The deductible — and therefore reportable — amount is **not** the employee's full overtime pay. It is only the **premium portion above the regular rate**.
Example: - Employee's regular rate: $22/hour - FLSA overtime rate: $33/hour (1.5×) - **Qualified overtime premium: $11/hour** (the difference)
Your current payroll system almost certainly records $33/hour as a single code. To comply with Code TT reporting, you need to split the overtime hour into two components: $22 at regular rate (Box 1) and $11 as qualified overtime premium (Box 12, Code TT).
This requires changes to payroll codes and pay rules — not just reporting configurations. Additional complexity arises when nondiscretionary bonuses or shift differentials are in play: the IRS requires you to recalculate the regular rate to account for those before applying the 1.5× multiplier, which then determines the premium.
What Does Not Qualify for Code TT
- Overtime paid to **FLSA-exempt employees** (salaried executives, admins, professionals)
- Overtime premiums **above FLSA minimums** — double-time or triple-time provisions in collective bargaining agreements or company policies don't qualify
- **Paid time off hours** counted toward the 40-hour threshold
- Shift differentials paid on regular (non-overtime) hours
What Counts as Qualified Tips (Code TP)
For tips, the key distinctions are:
**Qualifies:** - Cash tips voluntarily left by customers - Charged tips (credit card) passed through to the employee - Tips received via tip-sharing arrangements, where the receiving worker is in a qualifying occupation
**Does not qualify:** - **Mandatory service charges** — an 18% gratuity automatically added to a bill is not a tip; it is ordinary wages - Tips negotiated between customer and worker - Tips received by workers in occupations not on the IRS's Treasury Tipped Occupation Code list
The TTOC requirement means you need to assign the correct occupation code for each tipped employee. The IRS publishes the approved list; common covered occupations include food service workers, hotel staff, salon and spa workers, casino dealers, and valet attendants.
The Penalty Math
The penalty for filing an incorrect or incomplete information return (which includes W-2s) ranges from **$60 to $680 per form**, depending on how late the correction is made:
| Scenario | Penalty per W-2 | |---|---| | Corrected within 30 days of deadline | $60 | | Corrected by August 1 | $130 | | Corrected after August 1 or not corrected | $340 | | Intentional disregard | $680 |
For a restaurant group with 80 tipped employees, that's $5,440 to $54,400 if the TP code is omitted entirely — and that's before considering penalties for incorrect amounts on the Code TT side.
What Employers Need to Do Right Now
The most urgent action is payroll system reconfiguration. The 2026 wages you are paying **today** need to be coded correctly so that year-end W-2 totals accumulate accurately. Attempting to reconstruct qualified overtime premiums from raw payroll data in December is expensive, error-prone, and in some cases impossible without original time records.
**Step 1 — Audit your overtime pay codes.** Does your payroll system separate the 0.5× premium from the 1.0× base for overtime hours? If not, this is a configuration change, not just a reporting change.
**Step 2 — Identify tipped employees and assign TTOCs.** Pull a list of all employees who receive tips. Match each role to the IRS approved TTOC list. Document this mapping.
**Step 3 — Verify that mandatory service charges are coded as wages, not tips.** This distinction matters both for the employee's deduction eligibility and for your Code TP reporting.
**Step 4 — Test year-to-date totals.** Run a W-2 test extract for Q1 2026 wages. Verify that Code TT and Code TP amounts appear correctly in Box 12 for affected employees.
**Step 5 — Brief your payroll vendor.** If you use ADP, Paychex, Gusto, or a similar provider, confirm when they are deploying the Code TT/TP updates and what configuration steps you are responsible for.
The Broader Compliance Picture for Employers in 2026
The OBBBA reporting requirements sit alongside a growing stack of employer wage compliance obligations in 2026. Pay transparency laws in 17+ states require salary range disclosure in job postings. Massachusetts and New Jersey are actively auditing for violations. California's pay data report is due May 13. And now the federal W-2 reporting update adds another layer: the specific composition of wages — not just the total — is subject to documentation and disclosure.
The common thread is that regulators at both the state and federal level are moving toward **granular wage reporting** — not just total compensation, but breakdowns by type, occupation, and demographic category. Employers who can generate accurate, code-level payroll data are positioned to handle all of these requirements. Employers relying on aggregate totals and annual reconciliations are increasingly exposed.
Stay Ahead of Employer Compliance Requirements
Regulatr's [Pay Transparency Compliance Tracker](/tools/pay-transparency) helps employers monitor wage reporting obligations across federal and state requirements — including deadline alerts for California pay data, multi-state posting compliance, and new W-2 reporting mandates as IRS guidance finalizes through 2026.