No Tax on Tips and Overtime: What 2026 W-2s Must Show

"No tax on tips" and "no tax on overtime" are among the most talked-about parts of the One Big Beautiful Bill Act (OBBBA). For employers, the headlines leave out the part that lands on your desk: the 2026 Form W-2 has new reporting requirements, and your payroll system has to capture the right numbers before the last payroll of the year. This Briefing explains what Los Angeles restaurants, salons, contractors, and other employers need to report, and what does not change.

These Are Deductions, Not a Payroll Exemption

The new rules let eligible workers claim a deduction on their own federal income tax return. They do not exempt tips or overtime from payroll taxes. The 2026 General Instructions for Forms W-2 and W-3 state that tips are still generally subject to federal income tax withholding and to both the employer and employee shares of Social Security and Medicare tax if the tips received are $20 or more per month. Overtime compensation is likewise still generally subject to federal income tax withholding and both shares of Social Security and Medicare tax.

In other words, keep withholding and depositing as you do today. The change is in what you report.

The Worker's Side: The Deduction Limits

According to the IRS, the deductions work as follows for tax years 2025 through 2028:

• Qualified tips: up to $25,000 per year of voluntary cash or charged tips, including tips received through tip sharing, in occupations that customarily and regularly received tips.
• Qualified overtime: up to $12,500 per year ($25,000 on a joint return) of the pay that exceeds the regular rate, generally the "half" in "time-and-a-half," when that overtime is required by the Fair Labor Standards Act (FLSA).
• Phaseout: both deductions phase out for modified adjusted gross income over $150,000 ($300,000 for joint filers).

Mandatory service charges added to a bill are not qualified tips, according to the W-2 instructions. If your restaurant adds an automatic gratuity for large parties, that amount is treated differently from a voluntary tip.

What Goes on the 2026 W-2

The 2026 W-2 adds two new Box 12 codes and a new box for occupation codes:

• Box 12, code TP: the total amount of cash tips the employee reported to you. "Cash tips" includes tips received in cash, charged, or under a tip-sharing arrangement.
• Box 14b: up to two Treasury Tipped Occupation Codes for the employee's tipped occupations. The Form W-2 instructions to employees explain that if only code 000 appears, the tips are not qualified tips and the TP amount should not be used for the deduction.
• Box 12, code TT: the total amount of qualified overtime compensation. Only the premium portion counts. For time-and-a-half, report only the "half."

Copy A of the 2026 Forms W-2 and Form W-3 must be filed with the Social Security Administration by February 1, 2027, according to the W-2 instructions.

The California Overtime Trap

California wage law requires overtime in situations federal law does not, such as daily overtime and double time. The federal deduction, however, is limited to overtime "required under section 7" of the FLSA, which is based on hours over 40 in a workweek. Based on that definition, overtime premiums paid only because California law requires them do not belong in code TT.

For many LA employers, that means payroll has to separate overtime into two buckets: the FLSA-required premium that goes in code TT, and California-only overtime that does not. Talk with your payroll provider now about how its system makes that split, and test it on a few employees with mixed weeks before the year-end run.

California Still Taxes Tips and Overtime

California did not adopt either deduction. The Franchise Tax Board's Summary of Federal Income Tax Changes states that California does not conform to the deductions for tips or overtime, but does conform to the new W-2 information reporting. For employers, that means:

• California wages and California income tax withholding are unchanged.
• Employees may ask why their federal refund changed while their California balance did not. A short note in your year-end payroll communication can head off confusion.
• Employees who expect a large federal benefit may want to revisit their Form W-4, while their California withholding stays the same.

For more on how far California's rules diverge from federal law, read California Does Not Follow the New Federal Tip, Overtime, and Bonus Depreciation Rules.

Year-End Action List for Employers

• Confirm your payroll provider is ready to populate codes TP and TT and Box 14b on 2026 W-2s.
• Assign a Treasury Tipped Occupation Code to each tipped position.
• Separate voluntary tips from mandatory service charges in your point-of-sale and payroll systems.
• Separate FLSA-required overtime premiums from California-only overtime.
• Reconcile reported tips and overtime for the year before the final 2026 payroll.
• Calendar February 1, 2027 for W-2 filing and furnishing.

This topic is part of our 2026 year-end tax planning checklist for California small business owners.

Key Takeaways

• The tip and overtime rules are federal income tax deductions for workers, not payroll tax exemptions for employers.
• 2026 W-2s report cash tips in Box 12 code TP, occupation codes in Box 14b, and qualified overtime in Box 12 code TT.
• Only the FLSA-required overtime premium counts, so California-only daily overtime and double time should be tracked separately.
• California does not allow either deduction, so California wages and withholding are unchanged.

If you want help reviewing your payroll setup before the final 2026 payroll, schedule a consultation with SMB CPA Group. You can also contact us, learn about our custom scope of work, or review our pricing.

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