How should employers report overtime pay on W-2s and payroll taxes?

1. The new law and what it demands from payroll systems

Congress created a temporary above‑the‑line deduction for “qualified overtime compensation” effective for tax years 2025–2028; that deduction covers the overtime premium (the portion above an employee’s regular rate) required under the Fair Labor Standards Act and is only allowable when the amount is shown on an information return such as Form W‑2 or Form 1099 ^{[1] [4]}. Employers therefore must be able to distinguish FLSA‑required overtime premiums from other pay so payroll systems can aggregate and report the qualified overtime amount accurately ^{[3] [6]}.

2. Transition year: voluntary reporting and penalty relief for 2025

The Treasury and IRS declared tax year 2025 a transition period: Forms W‑2 and 1099 will not be updated for 2025 and the IRS will not impose penalties on employers who fail to separately report qualified overtime or tips for 2025, provided employers otherwise file correct aggregate returns ^{[2] [7]}. The IRS explicitly encouraged employers to provide employees separate accountings — via Box 14 of Form W‑2, an online portal, a written statement, or other secure method — to help workers claim the deduction even if the W‑2 itself is unchanged ^{[2] [3]}.

3. What changes in 2026 and how employers should prepare

Beginning with tax year 2026 the IRS’s draft W‑2 instructions direct employers to report total qualified overtime compensation in Box 12 using code “TT”; employers should expect formal information‑return reporting obligations to apply and to be subject to normal enforcement then ^{[3] [8]}. Payroll teams must implement tracking by pay period, identify what counts as the FLSA overtime premium, and ensure third‑party payroll providers can export the required totals to W‑2 Box 12 ^{[6] [8]}.

4. Practical steps employers must take now

Employers should: (a) update payroll systems to flag FLSA‑required overtime premiums versus other supplements; (b) decide how to furnish 2025 information voluntarily (Box 14, portal, statement) because the IRS recommends doing so; (c) consult with payroll vendors about Box 12 “TT” support for 2026; and (d) retain records that support any “reasonable method” used to approximate qualified overtime for 2025 as the Treasury promised guidance on acceptable methods ^{[3] [9] [10]}.

5. Employer and tax‑practitioner concerns and differing takes

Tax practitioners warn that calculating the correct qualified overtime amount is complex — qualified amounts aren’t simply “all overtime pay” and may exclude non‑FLSA premiums; industry commentators note many payroll vendors lacked 2025 solutions and that misclassification could create downstream issues when formal reporting begins in 2026 ^{[6] [9]}. The IRS’s penalty relief eases immediate compliance risk, but several commentators emphasize that voluntary, clear employee communications for 2025 will reduce taxpayer confusion and audit risk later ^{[2] [5]}.

6. What employees need and how employers’ choices affect them

Employees can claim the deduction for 2025 even if employers do not separately report overtime, using IRS guidance and “reasonable methods” like pay stubs as explained in Notice 2025‑69; nevertheless the absence of W‑2 line‑item reporting in 2025 makes employer‑provided statements materially helpful to avoid mistakes on returns ^{[4] [5]}. Employers who furnish a separate accounting in Box 14 or a secure portal give employees the clearest path to claim the benefit correctly ^{[2] [8]}.

Limitations and final note: available sources do not mention any finalized Treasury regulation defining the single mandatory “reasonable method” for approximating 2025 qualified overtime — the IRS signaled such rules are forthcoming — so employers must balance conservative documentation with the IRS’s transitional relief for 2025 ^{[3] [2]}.