How will employers calculate and document 'qualified overtime compensation' to meet 2026 W‑2 reporting requirements?
Executive summary
Beginning with tax year 2026 employers must separately capture and report the portion of overtime pay that is an FLSA-required premium above an employee’s regular rate—“qualified overtime compensation”—on Form W‑2 (draft Box 12 code “TT”) and related 1099s, which means payroll systems, timekeeping, and accounting of bonuses and premiums must be retooled to isolate that premium and retain supporting documentation [1] [2] [3].
1. What “qualified overtime compensation” actually is — the IRS definition and limits
The IRS and Treasury define qualified overtime compensation as the portion of pay that exceeds an individual’s regular rate and is required under Section 7 of the Fair Labor Standards Act (the FLSA) for hours worked over 40 in a workweek, i.e., the overtime premium itself rather than total overtime pay, and the deduction is subject to annual caps—$12,500 per single filer and $25,000 for married filing jointly—under the OBBBA statute [1] [3].
2. The arithmetic employers should use — isolating the premium
Practically, employers must compute the premium by subtracting the regular-rate component from total overtime pay for each workweek; for a typical “time-and-a‑half” overtime rate that means the premium equals one‑half of the regular hourly rate per overtime hour (and, as practitioners note, one simple high‑level shortcut is that one‑third of total time‑and‑a‑half overtime compensation represents the premium) — but employers should follow week‑by‑week FLSA calculations because variations (double time, nonstandard premiums, piece rates, or bonuses) change the premium math [1] [4] [5].
3. Compensation that must be included in the regular rate calculation
When employers calculate the employee’s regular rate (the base against which the overtime premium is measured), non‑discretionary bonuses and other promised pay must be factored into that regular rate even if paid separately from regular payroll; discretionary bonuses remain excluded. That makes accurate tracking of all pay components during the pay period essential because what gets included in the regular rate changes the size of the overtime premium that will be reported [4].
4. Where and how employers will report the number on W‑2s and alternative methods during transition
The IRS published a draft 2026 W‑2 indicating Box 12 will carry the total qualified overtime compensation using a new code (draft “TT”), and the agency’s fact sheet confirms mandatory separate reporting begins for tax year 2026; until then transition relief allowed “reasonable methods” for 2025 reporting, including supplemental statements, Box 14 entries, or employee portals, but that relief expires for 2026 so employers must adopt the formal Box 12 reporting once forms are finalized [2] [1] [6] [7].
5. Recordkeeping requirements and documentation employers need to retain
Employers should retain weekly payroll registers, time and attendance records, calculations showing how the regular rate was computed (including how bonuses were allocated), and year‑end summaries that tie each employee’s overtime hours to the premium reported; payroll vendors and compliance advisors uniformly recommend testing system changes ahead of 2026 and furnishing employees with a clear year‑end breakdown to support employee deductions [8] [4] [6].
6. Practical implementation steps, vendor and legal caveats
Organizations must reconfigure payroll and timekeeping systems to tag overtime premiums separately, confirm vendor readiness to populate the new W‑2 field, train payroll staff on FLSA regular‑rate nuances (including bonus treatment), consider employee communications around the change, and watch for state follow‑on rules; practitioners warn that the 2025 transition relief and IRS notices (e.g., Notices 2025‑62 and 2025‑69 and Fact Sheet FS‑2026‑01) filled gaps but do not eliminate the need for precise, auditable computations beginning in 2026 [6] [1] [4].
7. Disputes, gray areas, and what remains unresolved
Several implementation questions remain susceptible to interpretation—how to treat atypical overtime premiums, retroactive payroll adjustments that cross calendar years, and coordination with state law—so employers should factor in potential audits, keep conservative supporting calculations, and monitor further IRS guidance as the draft W‑2 and FAQs could be revised before final forms are issued [1] [9] [10].