“No tax on tips” and “no tax on overtime” sound like payroll changes, so a lot of Dallas restaurant, salon, bar and service-business owners assume they should stop withholding on those amounts. They should not. Both are deductions your employees claim on their own tax returns. Your job as the employer is different, and for 2026 it is new: you have to report the right numbers, in new places, on every W-2. There was penalty relief for 2025. The IRS has said there is none for 2026.
Key Takeaways
- Employees can deduct up to $25,000 of qualified tips and up to $12,500 of qualified overtime ($25,000 on a joint return) for tax years 2025 through 2028.
- Both are income tax deductions for the employee. Social Security, Medicare, federal unemployment tax and Texas unemployment tax still apply, and withholding continues as normal.
- Qualified overtime is only the “half” in time-and-a-half, and only overtime the federal Fair Labor Standards Act requires.
- On the 2026 Form W-2, employers report tips in box 12 code TP, qualified overtime in box 12 code TT, and a Treasury Tipped Occupation Code in box 14b.
- The 2025 penalty relief is over. For 2026, employees cannot claim more overtime than you report, so a payroll mistake becomes their problem and then yours.
What the law actually changed
The One Big Beautiful Bill Act, signed in July 2025, created two new federal deductions for tax years 2025 through 2028:
- Qualified tips: an employee (or self-employed person) can deduct up to $25,000 of tips received in an occupation the IRS lists as customarily and regularly receiving tips.
- Qualified overtime: an employee can deduct up to $12,500 of qualified overtime compensation, or $25,000 on a joint return.
Both deductions shrink once modified adjusted gross income passes $150,000 ($300,000 for joint filers). For tips, the statute reduces the deduction by $100 for every $1,000 over that line.
Nothing about this is an exclusion from wages. The IRS is explicit that overtime compensation “is not excludible or exempted from wages” for employment taxes, and tips of $20 or more a month remain subject to income tax withholding and both halves of Social Security and Medicare. In Texas there is no state income tax to adjust, and tips and overtime still count as wages for Texas Workforce Commission unemployment tax.
Overtime: only the premium, and only FLSA overtime
This is where most payroll setups will go wrong. Qualified overtime compensation is only the premium portion: the extra half-rate on hours the Fair Labor Standards Act requires you to pay at time-and-a-half, which in practice means hours over 40 in a workweek for a non-exempt employee.
An example. An hourly employee earning $20 works 46 hours in a week. You pay 40 hours at $20 and 6 hours at $30, which is $980. The qualified overtime is 6 × $10 = $60, not the $180 of overtime pay. The IRS formula is excess hours × ½ × the FLSA regular rate.
Premiums you pay voluntarily or under a contract do not count unless the FLSA itself requires them. That includes daily overtime after eight hours, weekend or holiday premiums, and extra overtime under a union agreement. An employee who is exempt from FLSA overtime has no qualified overtime at all, whatever your policy pays.
Tips: the occupation matters
Only tips received in a listed occupation qualify. Treasury finalized the list in April 2026: more than 70 occupations, each with a three-digit Treasury Tipped Occupation Code. For example, 101 is bartenders, 102 wait staff, 603 barbers, hairstylists and cosmetologists, and 804 goods delivery people. The full list is at irs.gov/TippedOccupations.
Two things are not qualified tips:
- Mandatory service charges added to the bill. The IRS treats them as wages, not tips. If your Dallas restaurant adds an automatic gratuity for large parties, that amount is not a qualified tip.
- Tips earned in certain specified service businesses the law carves out. If you run a health, consulting or other professional practice where staff receive tips, ask before you assume they qualify.
What changes on the 2026 Form W-2
| Where | What goes in it |
|---|---|
| Box 12, code TP | Total cash tips the employee reported to you |
| Box 12, code TT | Total qualified overtime compensation, meaning the FLSA premium only |
| Box 14b | Up to two Treasury Tipped Occupation Codes. Enter 000 as one of them if any tips came from a non-qualifying occupation. |
| Box 14a | The old “Other” box, now split off |
Report the full amount, not the capped amount. If an employee has $30,000 of qualified overtime, code TT shows $30,000 even though the employee can only deduct $12,500. The cap is the employee’s calculation, not yours.
For 2025, IRS Notice 2025-62 waived penalties because the forms had not been updated, and employers could give employees the figures separately. That relief does not carry forward. The IRS has said no relief is available for tax years after 2025, and that employees may not claim more qualified overtime than appears in code TT. Errors need a corrected W-2c, and the usual information-return penalties can apply. The 2026 W-2 is due to employees and the Social Security Administration by February 1, 2027, because January 31 falls on a Sunday.
What to set up before year-end
- Ask your payroll provider whether it will populate codes TP and TT and box 14b for 2026, and how it calculates TT. Many systems store “overtime pay” as the full 1.5× amount.
- Confirm each employee’s FLSA status. Exempt employees have no qualified overtime, whatever your policy pays.
- Separate FLSA overtime from other premiums in your pay codes: daily overtime, holiday pay, contract premiums.
- Assign a tipped occupation code to every employee who receives tips.
- Keep tip reporting tight. Employees report tips to you by the 10th of the following month (Form 4070 or your own system), and large food and beverage establishments still file Form 8027.
- Keep service charges out of tips in your point-of-sale reporting.
- Keep withholding as normal. Only change it if an employee gives you a new Form W-4. The 2026 W-4 lets them account for the deduction in step 4(b).
If you have been paying hourly staff through a system that was never set up to distinguish these amounts, the cleanest time to fix it is before the last payroll of the year, not in January. For a wider look at Texas payroll obligations, see our payroll administration page, or call (214) 807-2440.
Not sure your payroll is ready for the new W-2 codes?
We will check how your system calculates overtime and tips, fix the pay codes before year-end, and make sure your 2026 W-2s report what your employees need to claim.
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Frequently Asked Questions
Do employers stop withholding tax on tips or overtime?
No. Both are deductions employees claim on their own federal income tax returns, not exclusions from wages. Income tax withholding, Social Security and Medicare continue as normal, and federal and Texas unemployment tax still apply. Withholding only changes if an employee gives you a new Form W-4.
How much can employees deduct?
Up to $25,000 of qualified tips, and up to $12,500 of qualified overtime compensation ($25,000 on a joint return), for tax years 2025 through 2028. Both deductions are reduced once modified adjusted gross income exceeds $150,000, or $300,000 for joint filers.
What counts as qualified overtime?
Only the premium portion of overtime the Fair Labor Standards Act requires, which is the extra half-rate on hours over 40 in a workweek for a non-exempt employee. Daily overtime, holiday premiums and overtime paid only under a union contract or company policy do not count.
Where do employers report tips and overtime on the 2026 W-2?
Cash tips reported to the employer go in box 12 with code TP, qualified overtime compensation goes in box 12 with code TT, and up to two Treasury Tipped Occupation Codes go in box 14b. Employers report the full amounts, not amounts capped at the deduction limits.
Is there penalty relief for 2026?
No. IRS Notice 2025-62 gave relief for tax year 2025 only. For 2026 the IRS has said no relief is available and that employees may not claim more qualified overtime than the employer reports in code TT, so errors should be corrected on Form W-2c as soon as possible.
Do automatic gratuities count as qualified tips?
No. Mandatory service charges added to a bill are treated as wages, not tips, so they are not qualified tips. Only amounts the customer chooses to leave, received in an occupation on the Treasury list, can qualify.
Sources: Internal Revenue Service, 2026 General Instructions for Forms W-2 and W-3 (codes TP and TT, box 14b, service charges); IRS Fact Sheet FS-2026-13, Qualified Overtime Compensation (premium portion, FLSA requirement, no relief after 2025); IRS Notice 2025-62 (2025 penalty relief); IRS final regulations on tipped occupations, IR-2026-49, and irs.gov/TippedOccupations; 26 U.S.C. §224 (qualified tips); IRS Topic 761 (tip reporting). Retrieved 2026-09-25. Guidance on specified service businesses is still developing; confirm current rules before relying on them.